For decades, McDonald's (NYSE: MCD ) has been one of the most popular fast food outlets for both breakfast and burgers alike. In fact, McDonald's most popular burger, the Big Mac, is sold more than 550 million times a year in the U.S. alone.
However, in recent months McDonald's has felt the heat on its two most prized categories. That's because Yum! Brands' (NYSE: YUM ) Taco Bell debuted its breakfast menu in March, while both Sonic (NASDAQ: SONC ) and Burger King Worldwide (NYSE: BKW ) have significantly improved their own burger offerings. Going forward, should McDonald's focus more attention on its breakfast or its burgers?
McDonald's first-quarter 2014 earnings
Going into earnings, McDonald's had reported four straight months of U.S. same-store sales declines. First-quarter earnings echoed more of the same, as U.S. same-store sales dropped 1.7% for the quarter. Revenue increased 1% to $6.7 billion. However, net income tumbled 5% to $1.2 billion.
During the conference call, management stated that breakfast currently contributes 25% of all U.S. sales and has the highest profit margin. When asked about the threat of Taco Bell's new breakfast menu, McDonald's management said that breakfast competition has gone on for years, but customers generally come back to McDonald's after testing new breakfast menus elsewhere.
It is estimated that retail food prices will rise 2.5% to 3.5% in 2014, up from just 1.4% last year. McDonald's stated that its commodity costs have already risen 3%, mainly due to protein costs, and it expects another 1% to 2% increase by year-end. Commodity costs could become a big factor in determining where McDonald's focuses its menu the most.
Should McDonald's focus on breakfast?
In 2013, customers reduced their restaurant visits at lunch and dinner times but increased their visits during breakfast hours. With more than 12.5 billion breakfast visits made to food outlets last year, a 3% increase, forecasts currently predict 7% growth over the next nine years in the restaurant industry overall.
Given the recent trends and forecasts, along with the fact that the average McDonald's location drew more than double the sales as second-place Burger King last year ($2.6 million vs. $1.2 million ), helped largely by breakfast sales, it may make sense for breakfast to be McDonald's No. 1 priority.
Additionally, while it is unlikely that Taco Bell will take over first place in the breakfast category any time soon, it does pose a threat to McDonald's in terms of market share and customer traffic. In an industry where margins and same-store sales are decided by just a few percentage points, Taco Bell's success during breakfast could become a big burden for McDonald's in terms of its growth potential and share price.
Coffee could also be a key factor in deciding which restaurant chain is more profitable during breakfast in the next few years. Coffee prices are now at a 26-month high, as prices have nearly doubled this year alone. While bigger chains in the coffee segment have locked in prices for at least the rest of this year, new entrants into the space may be at a disadvantage regarding commodity costs.
But what about the Big Mac?
Sonic now ranks higher than all burger chains and is tied for fifth place among 268 national brands in a recent poll given by the Temkin Group. The group analyzed feedback from 10,000 U.S. consumers across three elements: how well do experiences meet customers' needs, how easy it is for customers to do what they want to do, and how do customers feel about their experiences. Sonic's drive-in format succeeds in meeting needs and experiences while Sonic's customization-ability gives freedom to customers to make their orders how they want. .
However, the chain, which started in the South but has locations in 44 states today, also took first place among burger chains in 2013.
Burger King's Big King sandwich, which looks very similar to McDonald's Big Mac, appears to be gaining traction among burger lovers. It is currently seen as a better value at $3.69 since it has about 0.8 ounces more beef than the Big Mac.
Burger King's recent earnings showed a same-store sales reversal to the upside by 0.1% after falling 0.9% for 2013. Much of the positive earnings news was due to new menu items, led by the Big King.
Sonic and Burger King only represent a fraction of those threatening McDonald's burger market share. The extremely low barriers to entry in the hamburger space have allowed all types of restaurants, from fast food to full-service dining, to enter with their own burger menus.
However, consumer trends may foreshadow a future where burgers are less important than breakfast for McDonald's. Beef prices recently hit $3.55 per pound, a record high. With higher beef prices and healthier consumer eating habits, chicken has grown in popularity as the preferred choice in protein. On average Americans currently consume 82 pounds of chicken per year and just 57 pounds of beef.
In an ideal world, it would be best if McDonald's could focus on both breakfast and burgers equally. However, one of McDonald's biggest problems in recent years has been a scattered strategy across multiple business segments.
McDonald's has historically dominated breakfast, and it may be best for the company to pay attention to new entrants like Taco Bell. This is especially true since breakfast is such a big factor to McDonald's bottom line.
Consumer habits suggest that beef is not as popular as it once was. And because the burger segment is so heavily fragmented, it may not be the best use of resources now for McDonald's to pursue making any changes to its existing burger lineup.
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