THE ECONOMIST: Hungry investors are McLovin McDonald’s right now. But do golden arches have silver linings?

The success of the Golden Arches rests on three simple, sturdy foundations: a menu of reliably decent grub, at a decent price, shored up by catchy marketing. Ever since it went public in 1965, McDonald’s has done best whenever it stuck to this original blueprint. When one or more of these pillars crumbles, the fast-food fortress looks shaky.

A quarter of a century ago this led to a near-collapse. Overly rapid expansion in the number of outlets and, at the same time, of products on offer made it harder for burger-flippers to keep up, hurting reliability. A price war with Burger King turned downright indecent. And the ads were stale, too. The result was acid reflux for investors. Between late 1999 and early 2003 the company shed two-thirds of its market value.

The wobble in the first six months of 2024 was mild by comparison. But it still made investors nauseous. McDonald’s shares lost 16 per cent of their value between January and July, their worst half-yearly run since the global financial crisis of 2007–09. This time the wonky pillar was affordability, especially in America.

Post-pandemic inflation had pushed average McDonald’s prices up by 40 per cent from 2019. Videos of $US18 ($27) Big Mac combos went viral. The company’s own forgettable marketing efforts did not.

Realising its mistake, in July 2024 McDonald’s launched a $US5 ($7.50) meal deal, comprising a burger, fries, nuggets and a fizzy drink. In January it packaged this together with a “buy one, add one for $US1” offer and digital-only promotions in its app, which it called the McValue menu.

McValue’s memorable face is John Cena, a beefy wrestler turned Hollywood superstar. In another marketing coup, in March and April diners ate up Minecraft Movie Meals, promoted in collaboration with the video-game-inspired blockbuster, so fast that the included collectibles ran out a fortnight into the weeks-long campaign. A food-safety snafu affecting outlets in 14 states in October proved mercifully short-lived.

All this has worked a treat. On August 6 McDonald’s unveiled hearty results for the second quarter. Revenue, derived primarily from the licence fees, royalties and rents which franchise operators hand over to headquarters in Chicago, rose by 5 per cent, year on year, to $US6.8 billion ($10.2 billion).

The preferred industry measure of same-store sales increased by 3.8 per cent globally and 2.5 per cent in America, a big improvement on four consecutive quarters of no growth or worse. McDonald’s operating margin, already the industry’s envy, topped 47 per cent for only the fourth time in the company’s history.

Investors are lovin’ it, sending McDonald’s market value up by 3 per cent after the earnings announcement, to $US221 billion ($330 billion). They are certainly preferrin’ it to its fast-food rivals. The day before, Yum! Brands, which owns KFC, Pizza Hut and Taco Bell, saw its stock slip after its latest results came in less than finger-lickin’ good.

Those of Shake Shack and Chipotle, slightly fancier fast-casual chains, crashed by a fifth in the past month after each reported fewer takers for their burgers and burritos as middle-class American diners stayed away amid mounting uncertainty over the health of the world’s biggest economy.

As the earlier meagre quarters showed, McDonald’s is not unshakeable. But aspects of its business model do allow it to withstand recent shocks better than its competitors.

Take tariffs, which President Donald Trump is slapping on trading partners left and right. Given that America imports lots of food, from Brazilian beef to Colombian coffee, these levies are bound to raise restaurants’ costs. In the case of Chipotle, which runs all its own outlets, or Shake Shack, which operates 329 of its 579 eateries, tariffs result in a direct hit to the bottom line. For McDonald’s, these costs are borne by franchisees, who manage 95 per cent of its 13,500 American stores (and a similar share of its 30,000 or so foreign outposts).

Since their payments to McDonald’s are a function of sales rather than profits, franchise operators’ margins can shrink without necessarily hurting the brand owner’s earnings.

JPMorgan Chase, a bank, calculates that it would take cost inflation of 7.5 per cent for McDonald’s to feel any hit to net profit, and then only of about 1 per cent. A cost increase of just 2.5 per cent would dent Chipotle’s net profit by 4 per cent and Shake Shack’s by 9 per cent.

For less global rivals the tariff pain is compounded by a weaker dollar, the result of Mr Trump’s chaotic economic stewardship, which makes imports dearer still. McDonald’s, by contrast, peddles burgers in over 100 countries and earns 60 per cent of its revenues in other currencies, compared with 43 per cent for Yum! Brands, 3 per cent for Shake Shack and 2 per cent for Chipotle. A softer greenback boosts the dollar value of these foreign sales.

A premature McFlurry of excitement?

Yummy, indeed. Still, as investors digest the good news, they should consider two potential snags. First, McDonald’s frugal menu disproportionately attracts lower-income consumers. These diners, as the company’s CEO Chris Kempczinski admitted on the latest earnings call, continue to feel “a lot of anxiety and unease”. Rather than eat out, some are opting for groceries, notes Mr Dennis Geiger of UBS, a bank.

Diners with fatter wallets may prefer rival joints such as Chili’s, which offers a starter, main and drink for $US10.99 — and has waiters. McDonald’s risks ending up too pricey for the poor and not posh enough for the less so.

Keeping prices in check is, then, vital. Yet so is keeping franchisees happy. These two imperatives are in tension. Franchise operators are permitted to set their own prices — which explains why a Big Mac will set you back $US4.36 in Austin (the same in today’s dollars as the 45 cents the first one cost in 1967) but $US7.06 in Seattle. Urging them to flog McValue menus may squeeze them to breaking point, especially as their costs balloon. McDonald’s may be in a sweet spot right now. But this doesn’t mean things can’t sour.