This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

4 Reasons McDonald's is Losing its Groove

By Tim Begany

NEW YORK ( StreetAuthority) -- When it comes to fast-food stocks, one is head and shoulders above the rest. Certainly, nobody can touch it in terms of revenue, which, at $27.4 billion a year, is more than twice that of the closest competitor. The company's net profit margin of 20% is almost twice the industry average of 11%.

I'm referring to McDonald's (MCD), which I'm sure is no surprise. What may throw you for a loop, though, is that I think the stock can no longer deliver anything close to the 14% a year it posted during the past half-decade. So if you're looking for stocks with the potential to really trounce the market, then you might want to look elsewhere.

Considering how popular McDonald's is among individual and institutional investors, I understand my statements may come as something of a shock. However, there are several reasons I think McDonald's is about to fade.

1. Rapid deceleration in growth. Although sales have risen 8% annually during the past five years, and analysts see them continuing to expand at that pace in coming years, the bottom line is unlikely to cooperate as before. Indeed, analysts project earnings growth will decelerate to about 8.5% a year for the next three to five years -- a far cry from the 17.5% growth rate of the prior five years.

This sort of pullback often befalls large companies that have matured and are set to enter a much slower growth phase. After all, McDonald's already has 33,500 restaurants in 119 countries, including some pretty remote locations including Samoa, Venezuela and the Republic of Macedonia. At this point in the company's history, rapid growth is increasingly unlikely.

2. Fierce competition. McDonald's faces this in abundance from direct rivals including Yum! Brands (YUM) -- which owns Taco Bell, Pizza Hut and other brands -- Wendy's (WEN), Burger King and Jack in the Box (JACK). While none of these four enterprises is a match for McDonald's individually, they have combined sales of about $20 billion a year.

There's also a threat from fast-food alternatives such as Panera Bread (PNRA), a mid-cap firm with annual revenue of $1.9 billion and, in my opinion, far more growth potential than McDonald's. These so-called "fast casual" restaurants are rapidly expanding, despite somewhat more expensive menus, because of a reputation for having a wider array of healthier, more wholesome food choices.

In the case of Panera, those choices include sandwiches on whole grain bread and a variety of fresh soups and salads. The company capitalizes on growing demand for things like high-quality organic and all-natural ingredients and free-range chicken, and by making its menu accessible to those who don't use meat or dairy products.

The large-cap fast-casual chain Chipotle Mexican Grill (CMG), which generates annual revenue of $2.4 billion, takes a similar approach. McDonald's and the rest of the fast-food industry are far behind on these trends and probably too late to take ownership of them, setting the stage for potentially big losses in market share to the fast casual industry in coming years.

3. Commodity cost inflation. Rising energy prices and spiking costs for key product ingredients will certainly squeeze the margins and bottom lines of McDonald's and its competitors. In the past couple years alone, for example, the price of beef has climbed 33% and wheat has gone up 69%. Energy prices have soared, too, even with the recent pullback. As a group, oil, natural gas and coal are up nearly 50% in price during the past two years.

4. The bull's-eye on its back. Because McDonald's is the world's leader in fast food, it takes most of the blame for the link between fast food and obesity and for other types of bad publicity that affect the industry, even though competitors have similar products. This added burden places the stock at higher risk.

One of the latest examples of this is the "pink slime" controversy earlier this year. After starting 2012 at about $100 a share, McDonald's stock began to slide as the media regularly ran reports about hamburgers and other beef products containing a mixture of low-quality beef cuts (dubbed pink slime) that were banned for human consumption in the U.K. Between Jan. 1 and March 23, the stock fell nearly 5%, even though McDonald's announced on Feb. 1 it would no longer allow pink slime in its beef products. The stock has continued to trend lower and now sits at about $88 a share, or 12% below where it began the year.
1 of 2

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
AAPL $93.74 -1.15%
FB $117.58 0.73%
GOOG $693.01 0.29%
TSLA $240.76 -2.81%
YHOO $36.60 0.03%


Chart of I:DJI
DOW 17,773.64 -57.12 -0.32%
S&P 500 2,065.30 -10.51 -0.51%
NASDAQ 4,775.3580 -29.9330 -0.62%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs