McDonald's (MCD) expects food costs to rise between 4% and 4.5% in the United States and Europe this year, a situation that would put pressure on the company's profit margins. McDonald's is the market leader in the fast food business, with about a 19% share. In its primary operations, it competes with Wendy's (WEN), Subway, Burger King, and Yum! Brands (YUM), and, in its recent move into the specialty coffee market, it's going up against Starbucks (SBUX).
McDonald's plans to offset some, but not all, of its higher food costs through small price increases throughout the year. Although it has a size advantage in the fast food market, McDonald's is still finding it difficult to pass on its rising wholesale costs to customers.
Boosting what it charges for food could repel customers already facing a pinch in their pockets due to higher inflation. However, we believe McDonald's has an edge because it can raise prices on its premium offerings, such as its premium burgers and McCafe drinks, which appeal to higher-end customers.
According to CFO Pete Bensen, the company intends to sacrifice some short-term profit margin to protect long-term growth. McDonald's CEO Jim Skinner said "Customers are getting pinched everywhere. They should not suffer the same fate at McDonald's."
In March, McDonald's put through a 1% menu price increase in the U.S., where it plans additional increases. Prices in Europe are up by the same amount, and increases are also planned for China.
If McDonald's does pass its increased wholesale costs on to its customers, average spend per customer visit and annual customers per McDonald's restaurant could be adversely affected.
We currently maintain a $82.53 price estimate for McDonald's stock, roughly in line with market price.
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