That's how much it costs now for a big mac, a french fry and a coke. In 2019, the same meal would cost $7.50. What happened?
The reality of the fast food industry in America is fascinating, the country is awash with fast food restaurants and low value chains. The reality of the game is two fold: first the corporations that run the fast food industry have run against a fundamental large number problem – there's simply no room for expansion. The franchise that operates new restaurants cannot find "interesting opportunities" which translates into areas where there is a shortage of supply. In order to keep their stock prices up they have resorted to increasing the price of ingredients that the franchises have to purchase (including services). Over the past five years, despite virtually no additional outlets, and stagnant sales figures, companies such as McDonald have increased margins through higher prices, which translates into a 160% increase in the cost of a McDonald meal. About 15 years ago, a broker did the analysis, and he showed that a $6.50 big mac meal would cost the average consumer (to reproduce) $4.65. It was an attractive bargain and it showed as nearly 50% of Americans consumed a McDonald at least once a day.
At the same time as McDonald has increased its franchise revenues it has increased the value of its real estate. At heart, McDonald is a real estate play with a positive cash flow (aka revenues from franchises). What McDonald has done, correctly by the way, is to increase the implied value of its land holdings. McDonald corporation has borrowed massively against these land holdings. The increased value has trickled down into the profit and loss of the corporation. It became a self re-enforcing cycle.
The problem now is that the cost of reproducing a Big Mac meal is about $8.75. The gap between the cost of "self production" has risen from $1.90 to $8.25. Suddenly, that has become a significant amount. The reality of the American consumer is that they are dumb but are not stupid. If they go to McDonald as a family of four they spend $70.00. Suddenly it is a large expense, and they can easily see that they can largely replicate that meal for a lot less.
The impact has been declining sales for McDonald. They are the best known, but over the past 18 months a large number of cheaper restaurant solutions and fast food chains have gone bankrupt.
All this is very interesting at a market level, but for investors the situation is more complex. The restaurant industry is an important component of the REIT industry (real estate investment trusts). The recent bankruptcies have resulted in higher costs for new products – and refinancings. The double whammy for McDonald, since the value of the REIT will fall as the yield requirements rise. That means that what was once a source of additional profits had vanished.
The American stock market is a strange animal. It is large, it is deep and at times it is irrational. Even the stock market eventually realises that there's a real problem. Like many other American corporations, McDonald has extracted all the value it could from its customers, and they have no idea how to resume growth. McDonald will probably survive in one form or another, but changes are already afoot.
Note: Someone pointed out to me that in food courts McDonald is at a great disadvantage because others sell burgers and fries. According to many of them, some of these small shops have a 30% to 40% price advantage.
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