McDonalds Corp (MCD) held its annual meeting last Thursday, May 22nd, and stated it has no plans to tamper with its highly successful dollar menu, which accounts for 14% of the company's sales. However, The Golden Arches must wish that its dollar menu was on the McGold standard instead of being based on a currency that has fallen 40% in the last 6 years. That dollar decline is putting the squeeze on the Oak Brook, Illinois-based firm, as agricultural input prices are surging while consumer food prices are only up about 4% since last year.
Indeed, the price of food ingredients has risen sharply in recent years. Since the start of 2006, rice is up more than 200%, wheat more than 130% and corn has increased 125%. Meanwhile, the World Bank has stated that average food prices are up 250% since 2002.
Unfortunately, the future also looks bleak. According to projections from McDonald's itself, the price of cheese should increase another 13-14% in 2008 alone. While it is true the higher input cost of agricultural commodities is partly due to wealthier consumer's diets in developing economies as well as the ethanol phenomenon, the falling dollar is responsible for much of the elevated prices in many commodities. For example, if the US dollar kept parity with the Euro the price of oil would be just over $80 a barrel instead of $133 where it is today.
One must wonder how much longer the dollar menu can be priced in dollars. Perhaps a suggestion would be to price the menu in Euros. However, what is more likely to occur is that they will keep the menu at par and use something akin to reverse hedonics.
Hedonics, of course, is a method used in the calculation of the Consumer Price Index which reduces prices for improvements made in the quality or features of a good or service. In the case of McDonald's it may be necessary to reduce the quantity or quality of items on the dollar menu in order to maintain the price. If neither of those methods is employed, it is reasonable to deduce that a serious compression of the company's margins would occur and impact their earnings going forward. The bottom line is that the consumer will most likely be hurt by reduced quality, higher prices or a combination of both.
The company's CEO Jim Skinner said last week that they would try to allay higher food costs by speculating in the futures market. While I'm not at all confident investors can count on the trading skills of Ronald McDonald to defray higher input costs, Skinner himself admits that not all costs can be offset. Under this environment of pricing pressure, it is astonishing that the company's stock is up 15% year over year and has a trailing P/E multiple of nearly 20. Aside from its international growth prospects, the most plausible explanation is that the highly stressed consumer is downsizing his cuisine standards and switching from more upscale dining.
Still, the company faces very difficult choices as it struggles to maintain cost and quality. Will McDonalds' costumers soon borrow a slogan from Wendy's and ask, "Where's the beef"? To maintain its dollar menu, diners at McDonalds may have to look forward to eating hamburgers containing a series of ever-smaller concentric circles as their patties suffers from the dreaded "shrinkage." Unfortunately, to maintain its dollar menu, the company may have to become a microcosm of America's shrinking standard of living.
We all have a lot to worry about indeed when the US dollar loses value against the Happy Meal.
*I discuss inflation in greater depth this week in my podcast, The Mid-Week Reality Check!
