McDonald’s Two Golden Arches

The traditional profit recipe for a dollar in the fast food burger business is that 30 cents should cover food costs, 30 cents should cover labor costs, 30 cents should cover occupancy costs, and ten cents should be left in profit.

McDonald’s stock hit an all-time high in the summer and is well-positioned to go higher thanks, in part, to the positive outlook for labor costs and low food costs.

As we noted in a recent column, wage growth in the United States is tepid (about 2.5% for the year), indicating that there is considerable slack in the official unemployment rate reported by the Bureau of Labor Statistics (BLS), which indicates that the economy is supposed to be close to full employment.

Nowhere is the slack in the official unemployment rate more evident than in the food service industry. Employment in food services and drinking places rose by 53,000 in July alone and the industry has added 313,000 jobs over the year. Meanwhile, the BLS’s unemployment numbers have barely budged, with most of the workers apparently ‘returning to the work force’ after being in the ‘non-participating’ category.

McDonald’s is getting favorable attention from influential analysts like Andrew Charles of Cowen & Company because of its plan to further reduce labor expenses by introducing new digital ordering kiosks (without cashiers) in 2,500 restaurants in 2017.

 

In addition to manageable labor costs, food prices, measured in terms of inflation, are historically low. The cost of food in the United States increased just 1.10 percent in July of 2017 over the same month in the previous year. According to the BLS, food Inflation in the United States averaged 3.43 percent from 1914 until 2017. Futures markets across agriculture indicate a buyer’s market, especially in the important cattle, hogs and chickens category.

We say that McDonald’s positive profit outlook is only partly due to a positive outlook for labor and food costs. These factors are common to all businesses in the restaurant space. The chart below from Goldman Sachs shows that McDonald’s also runs a reasonably tight ship with respect to maintaining a consistent and reliably pleasant dining experience in the opinion of the people that matter, i.e. its customers.

 

About Chris Donnelly

Christopher J. Donnelly, is an experienced attorney, bond analyst and fixed income strategist, with years of experience in structured finance, distressed bonds and bond related litigation in a variety of industries and the emerging markets. He is a graduate of Rutgers University (BA), The University of Pennsylvania (JD) and New York University, (LLM in Taxation). Chris is a Managing Director of Straacom, LLC and can be contacted at cdonnelly@straacom.com. Straacom provides strategic research, analysis and communications for publication and on assignment for private clients.

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