Navigating the Slow Recovery: Restaurant Sales and Traffic Struggle to Rebound
So far in 1Q24, according to the NRA survey (and Black Box), the restaurant industry faces challenges as same-store sales and customer traffic remain below pre-pandemic levels. Despite a slight improvement from January, restaurant operators reported a net decline in sales and traffic in February compared to last year. According to the survey, 38% of restaurant operators experienced an increase in same-store sales between February 2023 and February 2024. This figure represents a modest improvement from January 2024, when only 24% of operators reported higher sales. However, most operators (51%) still saw a decrease in sales compared to the previous year, although this is down from 69% in January. The survey also revealed that customer traffic remains a significant concern for restaurant operators. In February, only 26% of operators reported increased customer traffic compared to last year. Conversely, 56% of operators experienced a decline in traffic, marking the 11th straight month of net declines in this metric. We are modeling that March traffic will improve sequentially but still be negative.
Lamb Weston Navigates Near-Term Challenges
Based on the earnings call, Lamb Weston is seeing softer demand in the near term, particularly in the fourth quarter of fiscal 2024 (MCD is their largest customer). For a more comprehensive, long-term perspective on Lamb Weston (LW), please refer to today's @HedgeyeStaples note. We remain SHORT MCD & SYY for the issues LW talked about on its earnings call:
Restaurant traffic trends: In the US, restaurant traffic has dropped slightly over the past 6-9 months as consumers adjust to the cumulative effect of inflation on menu prices. QSR traffic was flat in Q3 after growing modestly in the first half of fiscal 2024. Full-service restaurant traffic has declined each quarter during fiscal 2024. Internationally, restaurant traffic growth has also slowed sequentially in most of LW's key markets.
Consumer pressure: Several QSRs (MCD) have attributed the slowdown to fewer visits by lower-income consumers whose disposable income has been more affected by the inflationary environment. LW believes the pressure on restaurant traffic, and demand is temporary but is taking a more cautious view of the consumer in the near term.
So, what is wrong with MCD? See below:
McDonald's Struggles with Menu Price Inflation Amidst Economic Challenges
McDonald's is grappling with a significant issue that has gripped the entire industry: menu price inflation. Johnathon Maze from Restaurant Business highlighted that the fast-food sector has seen a staggering 29.5% price increase since February 2020, outpacing the 24% inflation in full-service restaurants. This alarming trend is primarily due to sharp increases in wage rates, food costs, and other expenses. McDonald's has not been immune to these pressures, but have they taken things too far? While the iconic Big Mac has seen a relatively modest 16.4% price increase, the Cheeseburger has experienced a whopping 55% surge, from $1.55 to $2.40. This aggressive pricing strategy is a notable shift away from the brand's once-popular $1, $2, and $3 value menus, which drove significant traffic from price-sensitive consumers. Perhaps most concerning is the pricing comparison between McDonald's and casual dining chain Chili's. For a family of three, a meal at Chili's under their "3-and-Me" deal costs $39, while a comparable meal at McDonald's totals $36. Even with a 20% discount through the McDonald's app, the price difference is minimal, although this doesn't account for the tip when dining in.
McDonald's franchisees can set prices based on local market conditions, leading to inconsistent pricing and customer experience across locations. This, coupled with the overall price increases, has resulted in a decline in traffic as consumers grow increasingly concerned about affordability. The shift from traditional value menus to app-based promotions reflects McDonald's attempt to navigate these challenges. However, as highlighted by Darden last week, the broader economic impact of inflation is particularly affecting lower-income consumers, leading to reduced dining out and a heightened focus on affordability.
As McDonald's and other fast-food chains grapple with maintaining profitability while preserving customer loyalty, how they will adapt their strategies to address these pressing concerns remains to be seen. The delicate balance between managing costs and meeting customer expectations will be crucial in determining the future success of these businesses in an increasingly challenging economic landscape.
McDonald's Acquires Israeli Restaurants Amid Geopolitical Tensions
McDonald's Corp. has agreed to acquire its restaurants in Israel from operator Alonyal Ltd., which has been running the local chain for over 30 years. The decision comes after the Israel-Hamas war, during which franchised stores in Israel faced controversy for providing meals to soldiers. The acquisition is expected to be completed in the coming months, and McDonald's plans to look for a new franchisee for its Israel business shortly after.
Besides the domestic pricing issues, this acquisition highlights other critical themes impacting McDonald's:
- Geopolitical tensions: The Israel-Ham as conflict has put pressure on McDonald's to address the actions of its franchisees in the region, as operators in Saudi Arabia, Malaysia, and Pakistan denounced the Israeli stores' support for soldiers.
- Brand reputation: McDonald's CEO Chris Kempczinski condemned violence and hate speech and expressed concern over acts of antisemitism and Islamophobia, highlighting the company's need to navigate sensitive political and social issues to maintain its global brand image.
- Financial performance: The conflict in the Middle East has negatively impacted McDonald's fourth-quarter sales and will also hurt 1Q24. This acquisition emphasizes the continued potential financial risks of operating in regions with ongoing geopolitical tensions.
