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After Tough Q2, McDonald’s, Chipotle Put Hope in Meaty Deals

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July 12, 2016
Fast food market continues to experience slow financial growth.

It seems to be getting harder for fast food companies to convince financially struggling consumers that they deserve a break.

Visits to fast food restaurants have been growing at a “snails pace,” and were flat for the first five months of 2016, according to market research firm NPD Group Inc. “All in all, the restaurant industry has been conducting business in a one percent world since 2010, and will continue at the same pace for several more years,” NPD said in a report released last month.

Slowing job growth and higher gas prices may have contributed to recent reluctance to dine out, analysts say, and that could mean tough sledding for companies like Chipotle Mexican Grill, Inc. (CMG), and McDonald’s Corp. (MCD), which are scheduled to report Q2 earnings on July 21 and July 26, respectively. A stronger U.S. dollar and potential Brexit-related jitters may pose an additional challenge for MCD, with approximately 35% of the company’s operating profit generated in Europe.

Still, there are some bright spots. Breakfast sales at MCD seem to be stronger, and CMG is taking steps to lure customers back after last year’s food safety scare. McDonald’s is also trying new promotional strategies to bring in patrons. These deals haven’t seemed to attract investors to the two companies’ stocks, however, as the chart below shows.

Food and Beverage Stocks

FIGURE 1: TOUGH Q2 FOR BURGER AND BURRITO INVESTORS.

Stock prices for McDonald’s and Chipotle, seen here combined during Q2, have lagged the S&P 500 Index (SPX), in recent months. Data source: S&P. Image source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Brexit, Stronger Dollar, Seen Among Challenges For Golden Arches

Early indications point to sluggish Q2 same-store sales for MCD, and the Brexit vote, which is more of a long-term development, hit MCD stock with a thud. Additionally, the U.S. dollar has climbed vs. some other major currencies, including the euro, which may also pose another potential challenge for a company with such a large overseas presence. Shares of the company, which had risen above $130 in May, were recently down moderately from those levels and about flat for the year.

Even before Brexit and the associated rise in the dollar, things didn’t look particularly sizzling for the burger company.

"While U.S. restaurant industry same-store sales trends remain weak, as they were in first quarter, it's clear that U.S. burger-sector same-store sales have decelerated meaningfully in second quarter,” Nomura analyst Mark Kalinowski wrote in a recent note to investors. Nomura downgraded McDonald’s to neutral, with the bank lowering its Q2 same-store sales forecast to a 2.4% increase.

McDonald’s has been trying to lure customers with promotions, including a “2 for $5 deal” that priced two classic menu items for $5. But the company eliminated its popular $1 menu earlier this year because it wasn’t profitable for many outlets, and that’s created a “hangover” that analysts say could hurt Q2 sales. Meanwhile, some of the company’s premium-priced menu items are priced “perhaps too high for perceived quality," relative to competitors, wrote RBC restaurant analyst David Palmer in a recent note to clients.

A stronger dollar vs. the euro and pound, which seems to be the trend in the immediate wake of Brexit, could cause struggles for MCD going forward. The possibility of a Brexit-related recession also threatens. Struggling consumers often cut back on restaurant visits when times get hard, analysts say.

But don’t count MCD out in Europe yet. Some analysts note MCD’s 40-consecutive quarters of same-store sales growth in Britain, and say its position as a low-priced food provider could help amid economic uncertainty.

Also on the plus side, the shift to all-day breakfast continues to underpin MCD sales. Servings of breakfast foods increased by 8% industry-wide in Q1, NPD said, and breakfast sandwiches and other breakfast items topped the industry list of growing foods. Back in April, during MCD’s Q1 conference call, the company said breakfast items drove strong sales, and MCD beat analysts’ Q1 profit estimates. Whether MCD can surprise to the upside again in Q2 remains to be seen, but it’s worth monitoring earnings results to see if breakfast sales continued to perk up results for the company.

Can Chipotle Coax Cautious Customers?

Chipotle hopes its current strategy, which includes new menu items and a huge marketing effort, will bring customers back after last year’s e-coli scare.

Chipotle’s stock fell nearly 50% from its 2015 highs in the wake of an e-coli outbreak that sickened dozens across the country. Many customers deserted the chain’s restaurants, and the firm recently lowered its Q2 same-store sales estimates to a 20% drop from an 18% decline, Barron’s reported.

So how did CMG counter all the negativity? First, it added the “chorizo” to its menu. What’s a chorizo? CEO Steve Ells describes it as "a blend of chicken and pork spicy sausage, cooked on our plancha" with lots of "crispy bits, nice spice, and really good texture.” Listen on the Q2 earnings call for signs of whether this new item enticed customers enough to try Chipotle again.

Another way CMG tried to entice customers is through a rewards program targeting so-called “loyal” customers who regularly visit. The program, dubbed Chiptopia, lasts only through the summer, and rewards customers based on the number of times they visit Chipotle.

But even as CMG works to bring customers back, it faces industry-wide sluggish trends that could keep it from its goal. Visits to fast-casual restaurants like Chipotle fell 4% in May compared with the same month last year, NPD reported. Lower pay growth and higher gas prices seemed to be key contributors to the slowdown.

And CMG is hurting more than the rest of the sector due to the e-coli issue. In the first quarter, revenue fell 23% to $835 million, and comparative sales fell 30%. By some measures, each CMG restaurant has experienced an annualized loss of $350,000, Barron’s recently reported.

Currently, Wall Street expects Q2 earnings of 98 cents a share on revenue of $1 billion. Three months earlier, the earnings-per-share estimate was $1.73, Barron’s said.

One good thing: CMG doesn’t have huge exposure to Europe, so Brexit wasn’t seen as a big issue for its shares, analysts say.

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