A year ago, I opined that McDonald's (NYSE:MCD) would retest all-time highs in the not-too-distant future. While it has yet to do so, McDonald's stock did achieve a nice double-digit return for shareholders over the past year.
The basis for my argument was simple. The most dominant quick-serve operator in the world was no longer satisfied with being the biggest; it also wanted to be the best. Following the rapid deterioration of McDonald's stock price in 2003, management unveiled a new plan that focused on getting better, not just bigger, and the results speak for themselves.
The company closed fiscal 2006 with fourth-quarter income from continuing operations up 30% compared with the same period a year ago. Additionally, global same-store sales increased healthily by 6.3%.
As McDonald's moves into fiscal 2007, it's showing no signs of letting up. Global same-store sales for the month of December, which is included in the first quarter for fiscal 2007, improved in all regions of the world, with a net increase of 7.2%.
In its most recent quarterly earnings conference call, the leadership at McDonald's introduced a subtle shift of focus. Rather than just be better, it now wants to "get better at being better" in everything it does. This philosophy is no more evident than in how McDonald's has been transforming its menu over the past few years, with not just innovations (like McGriddles) but also with a push toward premium items. Given the importance of the menu to the company's long-term success, we will focus on getting a better understanding of what lies ahead for the McDonald's menu.
Staying fresh
One of the key reasons McDonald's has stormed back into relevance since 2003 is its emphasis on refreshing its menu. Now, the theme for 2007 seems to be "if the recipe works, don't change it" as it looks to continue developing its menu options in a more premium direction. In his prepared remarks, CEO Jim Skinner stated that the menu will continue to expand in fiscal 2007, with a particular emphasis on breakfast as well as chicken options.
For example, expect to see more premium chicken options in 2007. In the first quarter, McDonald's will introduce Chicken Selects and Snack Wraps to the U.K. market.
While premium chicken is growing in importance for McDonald's, during the call it was obvious that no menu items are more important to McDonald's than those of its breakfast lineup. Skinner said unabashedly during the question-and-answer session that McDonald's is the "clear leader" in the fast-food breakfast segment.
One area where we are likely to find changes in regard to its breakfast offerings is with its Dollar Menu. No specifics were given, but Skinner did indicate that in select U.S. markets, there is "work going on" to the Dollar Menu as it relates to breakfast.
Peppermint Mocha Frappuccino with that McGriddle?
Perhaps the most significant development to its breakfast lineup in recent quarters is the introduction of premium coffee. In light of the success it enjoyed with premium coffee in 2006, look for McDonald's to continue expanding its presence here.
The company has several test products under way, including specialty coffees, premium burgers, and breakfast burritos. Of these, Skinner revealed that some specialty coffees will likely be tested in certain markets in 2007.
McDonald's will never be confused for a Starbucks (NASDAQ:SBUX), but given coffee's surging popularity in recent years -- thanks in large part to Starbucks -- the move toward premium and specialty coffees makes good business sense.
China is, like, kind of important
Breakfast will be introduced to the Chinese market for the first time this year. But the menu in China will still largely focus on what has been working, and that is beef, chicken, and fish.
While we are talking about China, an interesting bit of information was revealed during the call regarding McDonald's recent alliance with China's largest petroleum retailer, Sinopec. Skinner indicated that the company opened up its first Sinopec drive-through restaurant two weeks ago in Beijing.
This agreement is significant because Sinopec outlets number more than 30,000 in China. And the agreement that McDonald's has with Sinopec is for 20 years, including a clause that grants the fast-food operator the right of first refusal. Essentially, this gives McDonald's the advantage of picking and choosing the best locations throughout the country. No estimate has been provided as to how many Sinopec-McDonald's locations there will ultimately be. Regardless, we do know that this is a huge opportunity for McDonald's.
Minimum-wage effect
One important note that came up during the Q&A is on menu-price increases. Historically, the company has raised prices annually just below the "food-away-from-home" inflation index, which has been "running at about 3% a year the last couple of years," said CFO Matthew Paul. In 2007, he estimates, it will probably come in a little higher, perhaps around 3.5%, as restaurant operations gear up for minimum-wage increases. Paul later added that despite the price increases over the years, guest counts have actually increased as well, and for him, that speaks "to the power of the brand."
But one concern is whether McDonald's can continue to maintain an attractive Dollar Menu in light of continued price increases. Skinner sought to alleviate those concerns when, in response to one analyst, he reaffirmed the importance of the Dollar Menu to its customers. He added that the company will do everything it can "to continue to maintain" its strong Dollar Menu position in 2007.
I'm lovin' it
McDonald's is, to use an overused cliche, a well-oiled machine. There are many accomplishments that one could point to in highlighting the company's efficiency, but perhaps the one that stands out most for me is its execution at the restaurant level. In 2006, comps improved through a 50/50 balance in customer traffic and average check amount. This is an ideal that any restaurant operator, or retailer for that matter, would love to achieve.
The company's pursuit of not only being the biggest but also the best must keep executives at Burger King (NYSE:BKC), Wendy's (NYSE:WEN), and many others up late at night. McDonald's will not benefit from a sale of another hot brand in 2007 the way it did in 2006 with Chipotle (NYSE:CMG), but with continued development of its menu to a more premium direction, it should keep giving the competition headaches.
I'm lovin' what McDonald's is doin'.
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Fool contributor Jeremy MacNealy has no financial interest in any company mentioned. The Motley Fool has a user-friendly disclosure policy of its own.
