COMPANY: McDONALDS
Introduction
McDonald's Corporation is the world's largest chain of fast food restaurants, serving around 68 million customers daily in 119 countries. Headquartered in the United States, the company began in 1940 as a barbecue restaurant operated by Richard and Maurice McDonald; in 1948 they reorganized their business as a hamburger stand using production line principles. Businessman Ray Kroc joined the company as a franchise agent in 1955. He subsequently purchased the chain from the McDonald brothers and oversaw its worldwide growth.
Problems faced by the company
1. Rising food prices:
Higher food commodity and energy prices have recently pushed up wholesale and retail food prices. The US Department of Agriculture predicts that prices will continue to accelerate during the first half of 2011, leading to a 2% to 3% rise in food price inflation for the year. McDonald's and other big burger chains have largely been unaffected so far, but that might soon change.
In a report last week, RBC Capital Markets analyst Larry Miller said McDonald's will raise prices by 2% to 3% to help offset its higher food costs. McDonald's declined to comment, citing a quiet period ahead of earnings next week. However, the chain's CFO Pete Bensen told analysts in October that while prices for beef and other ingredients were rising, the burger chain could deal with the increase.
But it may be too early to conclude that the Golden Arches will survive the inflationary pressures unscathed. Rising food prices could be a risk for McDonald's, says analyst Andy Barish of Jefferies and Company, even though the chain is largely safeguarded from such volatility because the vast majority of its operating profits, about two-thirds, come from franchises and royalties. While individual franchises might have a harder time dealing with rising prices given the sensitive demand of cost conscious consumers, it could eventually hurt profits of the overall chain if prices rise to levels where it makes it difficult for franchises to expand.
Barish doesn't see any major disappointments in sales or earnings this year, but rather a gradual slowing of earnings growth. He expects McDonald's to post 16% earnings growth in 2010, followed by 10% growth in 2011.
2. Limitation of beverages over burgers:
McDonald's increasingly diverse menu has helped it become the nation's best-performing restaurant company during the economic slump. The chain realized quickly that consumers have lots of options when it comes to food and drink and they want the option to stop at McDonald's for snack time as opposed to just regular meals. Creative drinks are the product du jour at the chain, with everything from fruit smoothies and specialty coffee drinks.
But beverages might only take the company so far. The Wall Street Journal recently cited a company email that disclosed that McDonald's peak lunch-hour business has been flat for five years. And the few analysts taking a bearish view of McDonald's 2011 outlook say real growth of the company's core business -- the burgers and fries part -- is overstated.
Howard Penney, restaurant industry analyst with investment research firm Hedgeye and a Fortune contributor, believes the chain has expanded too broadly into beverages, and the plan will eventually catch up with the company -- helping send U.S. same store sales to negative levels during the second, third and fourth quarters this year. Much of McDonald's success in beverages has come from specialty coffees such as lattes, which are sold at relatively higher prices. Penney says year over year sales growth of the pricier beverages has flattened.
"McDonald's makes a lot of its money on fries and beverages," Penney says. "So selling beverages is good but it makes operations more complex. It takes more to make a latte than to pour a Coke. To continue peak service time you have to add labor."
3. Insensitivity towards customers' belief (Vegetarians):
Facing a class-action lawsuit from angry vegetarians, McDonald's has confirmed that its French fries are prepared with beef extract, a disclosure the company said is not new. Although the fast-food giant has been saying since 1990 that its fries are cooked in pure vegetable oil, company spokesman Walt Riker said Wednesday that McDonald's never said its fries were appropriate for vegetarians and always told customers that their flavor comes partly from beef. The list of French-fry ingredients that McDonald's offers at its franchises and on its Web site includes potatoes, partially hydrogenated soybean oil and ''natural flavor.'' The list does not mention that the ''natural flavor'' comes from beef. To discover that, one would have to contact a McDonald's customer-satisfaction representative. Beef extract, not beef tallow, as the suit alleges, is the only natural flavor in McDonald's French fries, Riker said. Asked why the company simply did not write ''beef extract'' on its list of ingredients, he replied, ''It's a good question. We're sensitive to all our customers' needs and concerns. We try to be as forthcoming and user-friendly as possible. We'll review it. We'll take a look at it.''
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