My musings on the economy, life, technology, business and things I find interesting.

Tuesday, June 3, 2008

Do The Arches

If they didn't have me doing their stupid dance in the eighties they got me tonight. That's right two all beef patties special sauce, cheese on a sesame seed bun.

My wife and I worked late tonight and had a big proposal to get out by midnight. Her car broke down and other nonsense ensued, the end result was we ended up at McDonald's. A brand spanking new McDonald's in a new subdivision, with river rock exterior, trendy modern brickwork, stainless steel over hangs, a giant indoor playground rising up two stories and a multi station drive through. Fancy stuff indeed!

Quality You Can Taste?
Apparently that was their slogan in the 70s, I believe a far better burger chain has taken this moniker as their own, and actually made good on it, but I'll get to In and Out later. My wife and I were quite disturbed by the lack of choice on the menu, for all this talk about revamped menus and commitment to quality I was surprised at the dismal array of options. They offered two salads: lettuce with caesar or lettuce with ranch, onions and tomatoes, referred to, by name only, as caesar and garden. We ordered the "garden" salad and a chicken mcnugget happy meal for fun. The nuggets came out immediately the salads took about 5 minutes. Now the chicken mcnuggets were bar none the worst thing I've tasted in years, so we gave them back. They sent out "fresh" ones within 45 seconds, again the same putrid taste. I resolved to eat them doused in "bbq" sauce.

What You Want Is What You Get, At McDonald's Today
McDonald's is about as reliable for a good meal as the rating agencies are for truthful risk analysis, that is they're not. I can't believe how well McDonald's does when serving such slop. Their success only serves to undermine my faith in society, that we've come to be so accustomed to bland, tasteless mediocrity is incredible and to boot we'll pay top fast food dollar for it. There are lessons to learn from McDonald's, lessons to learn about the ability for businesses to make money hand over fist will serving markedly inferior products for a higher price then their competitors. As investors we must take note of the psychological and socioeconomic implications, because being a foodie in the 50s wouldn't have made you the kind of money Ray Kroc and his burgers in a bag would have.

There's nothing quite like a McDonalds's
It's quintisentially true, I really want to like McDonalds, I wish it tasted the way I remembered it, I wish it didn't upset my stomach, I really wish the burgers didn't come out of a wall of plastic drawers. 65 Billion market capitalization, incredible brand, always busy, a respectible PEG of 1.5, ROE of 16.6, decent leverage ratios, low debt to equity, strong dividend growth, good dividend yield, strong international growth. There is a lot to like about the golden arches. As a consumer they may get me to do the arches, but they won't grab me as an investor. The simple reason is the margin of safety is non-existent and the product is sub-par. Ultimately in the late 90s McDonalds was punished for their dwindling product quality and tarnished image. Although they shifted briefly I don't see the quality in their food and I sense a regression. Believe me I really want to see the quality, I would love to enjoy the memory of a tasty big mac once again, but every time I try I'm disappointed. Philosophically I can't believe that for long periods of time the markets will ignore this fact.

Alternatives
I'm not a restaurant analyst by any means, but I love food, I really love food. I'm also extremely busy and at times that means I'm eating out, and at times that means it's fast food. Let me tell you the list of places that trump McDonald's is long. One of my favourites is unfortunately privately held, In and Out Burger, it's not available up here, but when I worked in California it was an excellent alternative. So to name a few alternatives to McDonald's lets see (warning US restaurants aren't really covered):

  • Baja Fresh (US Only)
  • In and Out Burger (US Only)
  • A&W (Canada)
  • Tim Hortons (Canada)
  • Wendys
  • Arbys
  • Harveys (Canada)
  • Dair Queen (Highly Restaurant Dependant)
All of these places serve up better food, most of them actually grill their meat and it shows. Baja Fresh is ridiculous compared to McDonald's, probably the biggest differential on the list. When I'm in the states and I need fast food I go there.
Investing In Food
Do I own restaurant stocks? Yes absolutely, early this year many of the restaurant income trusts were very attractive, some have better expansion plans, same-store sales growth and franchise vs corporately owned structures then others so you need to take a detailed look, but overall good valuations, strong outlooks, good growth, strong brands and high payout ratios can make a lot of sense.
There are also the sit down operators like Cheesecake Factory, The Keg, Boston Pizza, etc. These seem like slightly worse plays in a downing economy, but I keep my eye on them in case the prices get compelling. None of these offer the same experience as a good chef cooking local food at a local restaurant so I don't find them as compelling in terms of where they fit in. Middle of t road restaurants can make sense in boom times for one simple reason: that's where most people will go for a night out. For many in Toronto the Keg/Boston Pizza is the same as Canoe, especially in the suburbs where local cuisine is crushed by the mega plaza eateries. I don't believe we're in boom times so I'm a little skeptical here.
Conclusion
There is a big difference between a burger and a steak, a latte and a cup of Jo. People will still go out in bad times I just think they'll feel better about it when they go some where cheaper. For this reason I favor the low end. McDonald's fits in with the low end, their attempt at upscale isn't showing up in their food and their price points are much higher then better tasting competitors. Today we ran out for two large cheese and pepperoni calzones, freshly stuffed and baked, served with vegetables and dip. The price for each was 2.53 including tax or around 5 bucks for two people. Compared to the McDonald's meal at $20 it was a real joke. The spreads in cost and taste are too large to ignore, thus I can't see McDonald's as a viable investment.




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