McDonald’s Cuts ‘Pink Slime’ off Menu — Will It Cut Profits?

by Kyle Woodley | January 27, 2012 1:21 pm

McDonald’s (NYSE:MCD[1]) clientele finally can rest easy. “Dog food” is coming off the menu at the Golden Arches.

In the wake of outcry by celebrity chef Jamie Oliver, McDonald’s said on Thursday said it would stop using ammonium hydroxide — a common ingredient in cleaning solutions that’s dubiously dubbed “pink slime” — in its beef patties.

McDonald’s beef producer, Beef Products Inc., says ammonium hydroxide occurs naturally in most foods and helps reduce bacteria. However, Oliver launched a personal campaign against its use in beef throughout the U.S. through his show, Jamie Oliver’s Food Revolution.

According to the Daily Mail, Oliver said beef producers take “trimmings” that would normally go to dog food and wash it with the compound until it is fit for human consumption.

“Imagine how happy an accountant is, you just turned dog food into what can potentially be your kids’ food,” he said to Food Revolution viewers.

A McDonald’s USA senior director credited the change to the restaurant’s priorities on food safety, not Oliver. But whatever the reasons, the move has been made.

If the use of “pink slime” is a great method to make low-grade meat fit for human consumption, a shift away from that — and toward better meat, unless a more favorable “cleanser” can be found — almost certainly means higher costs.

That’s not good news for McDonald’s, which has taken great pains to fend off rising commodity costs for everything from vegetables to beef to grains.

Like most McDonald’s workers will tell you, the fast-food chain is less restaurant, more factory. Unlike restaurants like Chipotle Mexican Grill (NYSE:CMG[2]) that are happy to shovel food at will and grow merely through adding stores, McDonald’s is a lean, mean portion machine that partitions every pickle and mechanizes every ketchup squirt. That — and its ability to purchase in seemingly endless bulk — helps outweigh the forces of food inflation.

Any significant increase to the price of one of McDonald’s staples, then, would be felt in its profit margins, which the company has seen plateau around or slightly above 20% for more than two years after a steady increase from around 10% a decade ago, and which fell slightly in the most recent quarter.

What should further worry investors is the coupling of this potential hit with McDonald’s less-than-bright outlook for 2012. One of the biggest problems MCD said it would face this year is volatile foreign currency cutting into its profits, but CEO Jim Skinner also noted other concerns, including ingredient costs.

McDonald’s already has shed about 2% since it reported earnings Tuesday, and it’s still trading at a P/E of 19, which is around its highest point since 2007. Combine that with a market that has come to expect nothing less than financial excellence from McDonald’s, and future signs of weakness could be met with even harsher reaction.

Investors currently are celebrating the fast-food giant’s most recent sterling earnings. But the loss of “pink slime” might in fact mean the loss of cash for what was the best performing Dow stock of 2011.

Kyle Woodley is the assistant editor of InvestorPlace.com. As of this writing, he did not hold a position in any of the aforementioned securities.

Endnotes:
  1. MCD: http://studio-5.financialcontent.com/investplace/quote?Symbol=MCD
  2. CMG: http://studio-5.financialcontent.com/investplace/quote?Symbol=CMG

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