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1 Reason McDonald's Struggles While Chipotle Surges

By John-Erik Koslosky – Feb 15, 2014 at 1:00PM

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The case of the so-called "yoga-mat" ingredient in chain-restaurant bread may shed some insight into why a company like Chipotle is enjoying surprisingly sustained growth, while McDonald's struggles to stem sales declines.

One of the most remarkable details of the Subway bread ingredient saga that made headlines nationwide last week was the response from fast-food standard-bearer McDonald's (MCD 0.63%). It highlights one reason the Golden Arches has been struggling at a time when former spinoff Chipotle Mexican Grill (CMG 0.42%) is surging.

The chemical in question is azodicarbonamide, and some bakeries use it to condition and strengthen their dough. But azodicarbonamide is also used to add elasticity to rubber products, hence its labeling in some headlines as a "yoga-mat ingredient" being added to bread.

Subway is far from the only food business that uses azodicarbonamide. In fact, most popular fast-food chains have it in at least some of their baked goods. But once word spread across the Web that it was adding the chemical to its famous fresh-baked foot-long rolls, the country's sandwich maker was swift to announce that it will stop using the substance.

"The complete conversion to have this product out [of] the bread will be done soon," was Subway's official statement.

It was a good move for a company whose motto is "Eat Fresh" and whose image is built upon the idea that it's a healthier option than the fast-food chains it competes with.

McDonald's, however, had a starkly different response to questions about the ingredient. Spokeswoman Lisa McComb told CNBC that the ingredient is recognized as safe, and it's approved by the Food and Drug Administration. She went on to say that all ingredients McDonald's uses in its food can be found on the chain's website.

"Natural" is different than "healthy"
While it's true that azodicarbonamide has been deemed safe by the FDA, McDonald's dismissive response should make investors wonder if the chain is tone-deaf to the broad consumer trend toward food that's not just healthy, but natural. This is a trend attracting not just the "health nuts" who try to stay in tip-top shape, but also many people who just like to know their food is safe and free from potentially harmful additives and antibiotics.

Consider that sales of organic foods -- which are not necessarily healthier, but largely free of chemicals -- grew from just $1 billion in 1990 to more than $28 million in 2012.

This can been seen with the rise of retailers like Whole Foods, The Fresh Market, and Sprouts. It can be seen in the aisles of your favorite supermarket, which probably has an entire section dedicated to natural foods.

"Food with Integrity" sells
It can also been seen in the terrific financial performance of Chipotle, whose "Food with Integrity" approach, combined with super-efficient operations, has the company growing fast at a time when many peers are struggling. Chipotle's fourth-quarter sales were up 21% over the prior year, surprising bears who thought the burrito maker's runway for growth was coming to an end. McDonald's revenue, meanwhile, was up 2%.

Granted, Chipotle can still add new restaurants at a far faster rate than McDonald's can. But a look at same-store sales doesn't improve the picture for the Golden Arches. U.S. same-store sales for McDonald's dropped 3.8% in December and 3.3% in January. At Chipotle, same-store sales were up 9.3% in the fourth quarter, and the company credited that to higher traffic.

Simply put, more people are choosing to eat at restaurants they believe are serving more natural food.

It came just in time for Dunkin' Donuts
Dunkin' Brands 
(DNKN) is another company that uses azodicarbonamide in some of its Dunkin' Donuts baked goods. But when reporters came calling, Dunkin' took a slightly different tack than McDonald's. "We are evaluating the use of the ingredient as a dough conditioner in our products and currently discussing the matter with our suppliers," its spokesperson said.

Some speculated that this was merely a less direct way of saying it will continue to be used. But Dunkin' will be an interesting case, since just last week, management was discussing how it plans to "take a responsible approach to where and how we source our products [and] ingredients." In fact, CEO Nigel Travis said it's one of the four key areas of focus for 2014.

"This is increasingly important to our guests," Travis said during the Feb. 6 earnings call.

He got that right, and the dustup over this chemical additive could be the company's first test.

The Foolish bottom line
Chipotle has been passing that test with flying colors, and customers have responded. Growth remains strong, and the future looks bright. McDonald's may not have to convince its core diners of the safety of the bread additive. But brushing off concerns over a chemical that has suddenly attracted national attention could alienate a growing group of potential customers.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool’s board of directors. John-Erik Koslosky owns shares of Chipotle Mexican Grill. The Motley Fool recommends Chipotle Mexican Grill, McDonald's, The Fresh Market, and Whole Foods Market. The Motley Fool owns shares of Chipotle Mexican Grill, McDonald's, and Whole Foods Market. 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.

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