It's no secret that the popularity of natural and organic food is rising to all-time highs in the United States, as organic sales saw a 12.9% rise last year . Caloric advertising has increased and portion sizes have gradually decreased across the food industry. Restaurants are now explicitly labeling nutritional content on their menus while fast food chains have promoted smaller versions of their most popular items. Beef, a traditional staple among American diets, has soared to all-time highs reaching $5.39/lb in August . Despite these trends, fast food stocks are actually better positioned than some healthier alternatives.
Fruit, Vegetables, and Big Macs?
On May 7, 2004, the world got to see (if they didn't know already) that eating at McDonald's (NYSE:MCD) daily might not be such a healthy habit. The movie Super Size Me sparked the discontinuation of McDonald's famous Super Size menu. Despite the movie's message, the stock has gone up over 375% since then, which includes a 10%+ gain this year alone valuing the entire company at just under $100 Billion.
However, sales have been flat recently. Profit margin has gradually declined during each of the past four quarters, going from 20.34% to a still respectible 19.71% . One of the big reasons for this margin decline has been the company's heavy reliance on dollar menu items . While dollar menu items are great for customers, the menu was originally intended to be an accessory to main menu purchases. The Wall Street Journal a few years ago stated that McDonald's earns just $0.06 per burger off the dollar menu. With sky-high beef prices today, it shouldn't be a surprise that margins have been affected negatively overall.
The dollar menu issue is clearly getting noticed by the chain, and the recent problems it has caused look to be more of a gift than a curse for McDonald's. At the end of September, McDonald's announced an initiative to add choices of salads, fruits, and vegetables instead of fries to its value menu by 2020, and the initiative will include both China and the U.K. in addition to the U.S. With beef prices at record-highs due to everything from last year's drought to America's overall shrinking cattle herd , McDonald's has placed more focus on chicken menu items which historically have been cheaper but more profitable.
Lastly, portion sizes can actually improve overall margins significantly. A typical McDonald's customer has a mind-set of what they want and expect to spend on a meal. While McDonald's focuses on its healthier menu additions, it can also promote 'healthy' by reducing burger and sandwich sizes, reducing the nuggets per box or the nuggets themselves, and modifying the fries containers so less fries are needed to make the containers appear full. Less food at the same price will result in higher margins and a much larger bottom line.
Almost $5 for Mac-and-Cheese?
The bottom line for Panera Bread (NASDAQ:PNRA) may be flat over the next few quarters. With menu prices that historically have been quite a bit higher than the average fast food restaurant, the chain has seen its stock soar over 200% over the past five years and it has reached a market cap over $5 billion. However, the stock has only gone up a little over 3.2% this year.
The chain is famous for its artisan baked breads, fresh foods, antibiotic-free chicken, and both organic and all-natural ingredients throughout the menu. However, a premium menu results in premium ingredient costs. As a consequence, the cost burden is placed on the customer.
Profit margins have never been above 10% for Panera with the most recent quarter hitting just 8.67% (less than half of McDonald's). Panera's 2nd quarter margins actually went up a little due to lower general and administrative expenses. While the first two quarters this year saw revenue and net income up 12% and 16%, respectively , Panera anticipates flat to slight margin declines on a year-over-year basis due to declining bakery-café margins.
Burrito Bowl's Kryptonite
Nothing seems to hurt Chipotle's (NYSE:CMG) stock, which has climbed over 610% the past 5 years, but its profit margin is another story. Year-over-year, profit margin has declined from 11.82% to 10.76% while the company's P/E ratio is now over 44. Higher costs for salsa ingredients, dairy items, and chicken, as well as marketing costs, are the culprits for the margin drop.
Like Panera, Chipotle prides itself on fresh ingredients free from antibiotics. However, recent beef prices seem to have affected Chipotle as the chain has posted signs regularly telling its customers that proper pork/beef is unavailable . At the end of September, Chipotle also changed its pinto beans recipe by ditching the pork so that the menu item will be totally vegetarian nationwide. However, the change seems too convenient because removing pork and charging the same price only improves the company's profit margin.
All 3 companies are within the 'quick service restaurant' industry. Despite the fact that both Panera and Chipotle try to distance themselves from 'traditional' fast food, all three options are on the minds of hungry people who want something quick to eat at a 'fast food' price. While McDonald's is trying to bring healthier components to its menus, it appears that Panera and Chipotle are running out of options to improve their margins. One of Panera's issues is its high menu prices in relation to its peers. Even with its high prices, margins will likely drop due to ingredient costs and the chain will have to make a choice of whether to give up on its premium menu or charge even more. Chipotle is losing a little of what made it special by breaking its organic menu traditions. As diets become healthier, so will McDonald's bottom line.
Michael Carter has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill, McDonald's, and Panera Bread. The Motley Fool owns shares of Chipotle Mexican Grill, McDonald's, and Panera Bread. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.