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What's Eating McDonald's


Its strength through the recession was much ballyhooed, but now sales are slipping

You'd think McDonald's (MCD) would be a can't-miss recession play for global investors. Yet shares of the fast-food giant are flat in 2009 during one of the most dramatic stock rallies in history. While the burger giant keeps growing overseas, same-store sales in the U.S., where McDonald's generates half its operating profits, dipped 0.1% in October and are likely to stay weak for the rest of the year. In response, McDonald's will soon launch a dollar breakfast menu and add smoothies to its lineup.

The problem: Rising unemployment, particularly among men aged 18 to 35, has slowed customer traffic. According to data tracker NPD Group, visits to fast-food restaurants declined 3% over the summer, the worst performance in decades. Traffic is notably weaker during the morning commuting hours, when McDonald's makes 25% of its sales. "That has really become a major negative for them," says Ronald N. Paul, president of restaurant consultancy Technomic. Moreover, families increasingly are eating at home: NPD says Americans will average 202 meals at restaurants in 2009, down from 211 in 2001. Thanks to improved operations, savvy marketing, and new items such as premium salads, McDonald's has posted 26 consecutive quarters of positive same-store sales in the U.S. But those buoyant sales have also been attributable partly to price hikes of as much as 10% in markets such as the Western U.S., according to internal documents circulated to franchisees that were reviewed by BusinessWeek. The price increases were a response to soaring costs for such ingredients as meat and cheese in 2008. While those costs have eased, McDonald's, like other fast-food chains, has kept its prices steady in an effort to maintain margins. As a result, says one divisional executive for the chain, "We're pricing ourselves out of the market" as consumers continue to pinch pennies.

To counter weaker demand, the Oak Brook (Ill.) company plans to extend its successful dollar menu to the breakfast hours beginning in January, according to internal documents. McDonald's has already been testing items such as $1 Sausage McMuffins in some markets, including the Southeast. One longtime franchisee who's doing so says customer visits have increased 5%, but overall breakfast sales have not improved.

DESIGNER COFFEE

McDonald's hopes the low-priced breakfast items will also boost sales of the company's premium coffee offerings, dubbed McCafé. Despite the hype so far, insiders say McCafé has not been the game-changer McDonald's had anticipated. "They're not lighting the world on fire," says the franchisee. The company plans to expand McCafé next summer to include smoothies.

What McCafé has done, some argue, is siphon off advertising dollars that could have been better spent battling McDonald's burger rivals, who are attacking the No. 1 chain with gusto right now. One notable advertising spot from Wendy's (WEN) claims that McDonald's uses frozen burger patties. A McDonald's spokesperson declined to comment.

With jobless numbers likely to rise well into next year, analysts are skeptical about the company's prospects in its home market. "This has been a remarkable run, but they need to turn around U.S. same-store sales," says Jeff Farmer, an analyst at Jefferies & Co. (JEFF) "And that's very difficult to do."

Boyle is deputy Corporations editor for BusinessWeek.

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