MCDONALD’S: Gross Margin at a 10 Year High. Here’s Why.

How can McDonald’s make money selling 99-cent burgers? That’s what Eric Kuang at Seeking Alpha wondered.  Then Kuang, founder of GuruFocus Capital Management, LLC., answered his own question… reinforced with some compelling stats showing why McDonald’s is thriving while others are struggling:

Well, maybe the company doesn’t make money off the 99-Cent burgers. Instead, the 99-Cent burgers are its symbols for value to attract customers. Once the customers are in the store or in the drive-thru line, they are bound to buy things other than 99-Cent burgers. They make money off those menu items, such as big Macs, hash browns, soft drinks, and all the other more expensive items.

As a matter of fact, according to the data available in Gurufocus, the gross margin for the fast food chain was 24.3% ten years ago in 1998, then it shrank to 13.7% in 2002, but has made a major comeback in recent years. In 2007, it was back to 24.3% again, and as of September 30, 2008, McDonald’s gross margin was at 28.4%, a high for the past ten years.

Gross margin is all important in determining whether a company worth the investment money…. despite the carnage of the general market, McDonald’s was up about 2% for the year 2008 whereas S&P declined 38.5%.

Kuang attributes McDonald’s sustained success to what Warren Buffett calls an “Economic Moat.”  Of companies with an Economic Moat, Buffett writes:  “The might of their brand names, the attributes of their products, and the strength of their distribution systems give them an enormous competitive advantage, setting up a protective moat around their economic castles.”

While that’s certainly true, I think many franchise companies that are doing well, like McDonald’s and Church’s Chicken (see CHURCH’S CHICKEN: Thriving in Hard Times), share another important trait:

They were already positioned for hard times before the hard times hit.



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