The 2014 Hunger Games: McDonald’s vs. Wendy’s

Fast casual restaurants like Chipotle (NYSE: CMG  ) now account for 5% of the quick service restaurant industry, according to a recent NPD Group study. In 2014, it is likely that fast casual restaurants will build on this momentum and take more market share away from traditional fast food chains. Fast food companies like McDonald's (NYSE: MCD  ) and Wendy's (NASDAQ: WEN  ) are still industry staples, however, and will continue to battle in the competitive restaurant scene. What should investors pay attention to when it comes to McDonald's versus Wendy's in 2014?

Do McDonald's overseas growth troubles hint something else?
Fourth quarter 2013 earnings for McDonald's will be released on Jan. 23, 2014. However, earnings may mirror the past few mediocre quarters since comp sales for the fast food giant have been relatively flat-to-negative for October and November, echoing the company's outlook during the third quarter 2013 conference call.

November comp sales were down 0.8% in the U.S. and down 2.3% for the Asia/Pacific, Middle East, and Africa (APMEA) segment.

McDonald's notes that negative results in their APMEA segment are due to Japan. In an attempt to bring back Japanese consumers, McDonald's is introducing a new "American Vintage " menu campaign that is set to debut from January to February 2014.

Comp sales performance within the U.S. may be less fixable and may hint at market saturation. With 34,923 restaurants, McDonald's has over 5 times as many locations as Wendy's and over 22 times as many as Chipotle. Because the majority of the locations are already franchised with the land owned by McDonald's, there are fewer routes for McDonald's to take in order to unlock more revenue streams.

Fish McBites, Mighty Wings, and McResource add to McDonald's problems

McDonald's Mighty Wings. Credit: McDonald's.

2013 was a string of bad innovations for McDonald's.

In the first quarter, McDonald's pulled the plug on its new Fish McBites. Later in the year, the infamous Mighty Wings resulted in 10 million pounds in unsold inventory. 2013 was capped off with McDonald's finally removing its McResource website in late December, which was designed to give support and advice to its own employees.

These problems hint that thorough market analysis has not been performed and McDonald's leadership may be lacking. As an example, not only were 50 million pounds of wings purchased for the limited fall promotion, but they were priced out of range for what consumers were willing to pay.

Product pricing is very important in the long term because if a meal at McDonald's keeps approaching fast casual prices of $8 or more, McDonald's may have more "Mighty Wings" scenarios in the future.

Can the new Wendy's continue its 2013 momentum?
In contrast to McDonald's, Wendy's recently raised its outlook during its third quarter 2013 earnings conference call. Revenues for the quarter were up, and same-store sales jumped 3.2%.

Wendy's is a limited-menu machine these days, and that may not be such a bad thing if they can continue to introduce menu blockbusters like the Pretzel Bacon Cheeseburger. The cult classic was one of the top new industry items in 2013, according to QSR Magazine. It was also a big reason why the company's stock jumped over 85% in 2013.

Another key reason why investors are excited about Wendy's is the company's plan to sell off 425 company-owned restaurants by the second quarter of 2014. The company is ahead of schedule, recently franchising several more locations at the end of December and bringing the total to 282 restaurants.

Somewhat overlooked is the fact that even after the 425 company-owned restaurants are sold, Wendy's will still have around 1,000 locations left to franchise if it wishes. It is a win-win situation because Wendy's will be able to save operational costs and create a steady stream of revenue from franchise owners. In the end, that means increased profit margins for Wendy's.

Credit: Wendy's

Lastly, Wendy's new Spicy Chipotle Crispy Chicken Sandwich and Spicy Chipotle Jr. Cheeseburger, each priced at $0.99, brings the company's "Right Price, Right Size" menu to 21 items. This is equal to the 21 items offered on McDonald's Dollar Menu, and may attract Chipotle restaurant customers that want to try out Wendy's version of the spicy flavor.

Investors should pay attention because this shows that Wendy's is playing the restaurant scene strategically. First, it is leveling itself with the biggest name in fast food – McDonald's. Second, Wendy's is following a recent 2013 Flavor Consumer Trend Report by Technomic, which shows that 54% of U.S. consumers prefer spicier foods. Lastly, Wendy's is maintaining low fast food prices and avoiding the prices of fast casual restaurants like Chipotle.

MCD Chart

MCD data by YCharts

Bottom line
It will be interesting to see how traditional fast food companies like McDonald's and Wendy's perform in the wake of rising fast casual chains like Chipotle. McDonald's has been performing relatively flat as a stock since the beginning of 2012. Could 2014 be the beginning of a new growth spurt? McDonald's will need to make better menu decisions and avoid PR blunders. If Wendy's is any indication of what's possible in a year, it could take just one popular menu item to get the momentum rolling. Wendy's still has plenty of room to run higher and could see significant price appreciation if it is able to meet its self-imposed franchise goals in mid-2014.

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