Earlier this month, Forbes released its annual list of the world's top brands. At the top of the list was Apple, followed by Microsoft, Coca-Cola, IBM, and Google (talk about diversity, eh?). It would be difficult to argue against this list of all-stars, but its No. 6 company, McDonald's (NYSE:MCD), welcomes some debate. Despite the company's tremendous size compared to its peers, the Golden Arches has been struggling for the past few years as newcomers like Chipotle Mexican Grill (NYSE:CMG) and Panera Bread Company (NASDAQ:PNRA.DL) have entered the neighborhood.
Growth has faltered
For the past five years, growth at the world's largest restaurant chain has been, for lack of a better word, lackluster. From 2008 through 2012, the company managed to grow its revenue by 17.2% from $23.5 billion to $27.6 billion. Though this is nothing to laugh at, especially coming out of a global recession, it falls far short of Panera's 64% growth and Chipotle's extremely impressive 105% growth. Now admittedly, both of these companies are a fraction of the size of McDonald's so they should be growing faster, but they aren't small by any means. Both have already surpassed Wendy's in terms of market capitalization and Chipotle is far larger than even Burger King Worldwide.
What this implies is that, as consumer tastes are moving away from fast food and toward the quick-casual dining experience, a change in the old guard is beginning to take place. This doesn't mean to imply that McDonald's is obsolete, nor does it mean to say that Forbes is wrong in giving it a seat at the top ten. In 2012, McDonald's saw its revenue come in $4.6 billion higher than Chipotle, Panera, Wendy's, Burger King, and Yum! Brands combined! Beyond any doubt, McDonald's is the biggest in its industry, but it might be reckless to base an investment thesis on this data point alone.
But margins are sky high!
Despite the new competition that has emerged in quick-casual chains, McDonald's does have one thing that they don't; high margins. In terms of net profit margin, McDonald's is superior by leaps and bounds. Over the previous five years, its net profit margin has averaged 19.8%, far more than Panera's 6.9% and Chipotle's 8.7%.
However, it should be taken into consideration that, while McDonald's has chalked up a net profit margin that has fluctuated between 18.3% and 20.5%, both Panera and Chipotle have seen theirs grow annually. Panera's net profit margin has risen from 5.2% in 2008 to 8.1% in 2012, while Chipotle's has performed similarly, rising from 5.9% to 10.2%.
The reason for this incline is that, as these restaurants grow, they are better able to take advantage of their market power to keep costs low. This point is demonstrated by looking at each company's cost of goods sold as a percentage of sales. In 2012 alone, McDonald's saw its cost of goods sold amount to 60.8% of sales. In contrast, Panera's cost of goods sold came in at 76.5% while Chipotle's was in the middle at 72.9%. What's more, both Panera and Chipotle have seen this metric decline almost every year for the past five years (2011 was the only exception for both entities), an indication that they might be on the way to matching McDonald's.
Currently, McDonald's is the largest restaurant chain in the world. Given this status and the prestige that comes with it, Forbes is probably right in claiming that it has the No. 6 brand value globally. However, just because the brand is so powerful today, does not mean it will remain this way forever. It is probable that McDonald's will continue leading the way for a long while, but investors should not buy shares thinking that it is immune from competition.
Competition is alive and well and McDonald's has the most to lose if it cannot keep up. This should serve as a warning to the Foolish investor, but it by no means suggests that the chain is on its deathbed. Its business is strong but any future growth will likely come at the cost of either accepting lower margins to compete on price and/or engage in innovation.