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Why McDonald’s Caffeine Problem Is Hurting Its Business

Breakout


Does McDonald’s Corp. (MCD) have a drinking problem that’s hampering its performance?

Over the past few years, McDonald’s has made a broader beverage offering a key priority, adding fancy coffee drinks and smoothies in a bid to capture some of the caffeinated customer traffic from Starbucks Corp. (SBUX) and Dunkin’ Brands Group Inc. (DNKN).

Related: Starbucks Set to Change the World, Again!

Howard Penney, managing director and restaurant analyst at Hedgeye Risk Management, blames this effort in large measure for the burger leader’s sluggish sales trends over the past two years.

“They went too far on the beverage initiative beginning in 2009 and really hurt the core business,” says Penney in the attached video. “They’re really losing customers at lunch and the stores are a little too inefficient because of the distractions they’ve put into the stores.”

With separate hot- and cold-beverage stations behind the counter, back-end workflow has been complicated. And yet Penney, who has followed McDonald’s and the restaurant industry since the 1980s, believes McDonald’s management is preparing to “double down” on the coffee push.


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McDonald’s will host an investor meeting on Thursday, and Penney thinks it’s likely that the company will “declare a coffee war in 2014,” trying to grab market share from Starbucks and Dunkin’ by undercutting their prices on espresso-based coffee drinks.

Penney says the fast-food incumbent has “an obsession with Starbucks’ business model.” That, he adds, isn’t a bad thing in itself, given the enormous growth, profitability and customer loyalty under founder Howard Schultz. But it’s important for a company to play to its own strengths.

“McDonald’s is known for food first, beverages second. Starbucks is known for beverages first, food second. Whenever you deviate from your core competency, something has to give,” he says. “McDonald’s is all about speed of service and whenever you’re distracted by doing things other than selling burgers, fries and Cokes, it really hurts their ‘throughput’.”

Even on the food front, of course, McDonald’s has gone quite a while without a true, enduring blockbuster new product, even as its menu has become overcrowded. Penney figures some 150 new menu items have been introduced since 2003, as the chain tries to appeal to non-core customers with salads and wraps and chicken wings.

Meantime, competitors such as Wendy’s Co. (WEN), with its pretzel-bun burgers, and Yum Brands Inc.’s (YUM) Taco Bell, with Doritos-brand tie-in tacos, have produced hits by serving up more of what their most avid customers crave.

The company last week reported that October same-store sales rose just 0.2% in the U.S. and 0.5% globally, continuing a two-year trend of decelerating top line growth. McDonald’s shares have badly lagged the broader stock market and the otherwise-strong restaurant industry.

Of course, McDonald’s has undergone periods of strategic muddle in the past, namely when it belatedly recognized a decade ago that it was expanding too much in slow-growing markets and curtailed store growth. And with a sturdy balance sheet, ample cash flow, and a 3.3% dividend yield, conservative investors might see the coffee cup as half-full for the stock.

Penney is skeptical, though. “I wouldn’t own it,” he says. “I think it will underperform.” Until, perhaps, McDonald’s brass addresses its drinking issues.

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