Temporary Shutdown Of Outlets & Agricultural Ban In Russia To Worsen McDonald’s Sluggish Growth

McDonald’s Corporation (NYSE:MCD) continues to face closures in the Eastern markets, as Russia’s food safety watchdog ordered the temporary closure of five McDonald’s restaurants in Moscow and Southern Stavropol region last week. The first four were closed on August 20. Russia’s consumer health agency – Rospotrebnadzor- claims that the targeted restaurants violated several sanitary laws, as reported by the local media. ^[1] Last month, McDonald’s faced similar problem in China over a food scandal, which disrupted its operations in China as well as Japan. ^[2] However, experts believe that the decision comes as a result of worsening U.S. – Russian political ties over Ukraine. Moreover, Russian President Vladimir Putin imposed a one-year ban on imports of agricultural products from countries that have imposed sanctions on Russia. ^[3]

The five stores, which are ordered to temporarily discontinue their operations include the one on Pushkin Square, which was the very first outlet in the country. Opened in 1990, it attracted a many fast food lovers in the area and went on to become the chain’s most visited outlet worldwide. However, Russian officials confirmed that they have shut only five out of 435 McDonald’s and that the suspension is temporary. Further decisions will be made after pending checks.

Whatever might be the reason, the fast food chain is facing serious consequences and if the situation does not improve, it might worsen the company’s already sluggish growth. In June-ended quarter, the company reported relatively flat global comparable store sales and 1% increase in consolidated revenues. In the U.S., comparable store sales decreased 1.5% while operating income rose 1%. ^[4] The company reported a mere 2% increase in net revenues and 2.2% increase in net income in 2013.

We have a $103 price estimate for McDonald’s, which is about 9.5% above its market price.

See Our Complete Analysis For McDonald’s Corporation

The fast food giant has already been struggling with stagnant revenue growth, declining margins and a decrease in customer traffic, driven by rising commodity prices and increasing competitive activity in the breakfast segment and from the fast-casual brands. Even though the company is trying to regain its market share by introducing innovative food and beverage products in the regular menu, strengthening its breakfast menu and improving its market campaign, it is still exposed to tough competition, both domestically and internationally. Weak economic conditions and losing consumer confidence in the U.S. are forcing the company to test unsaturated markets. As a result, McDonald’s has been concentrating more in other strong markets such as the U.K., France, Germany and Russia. The closure of the chain’s outlets in its key markets will deliver a blow to McDonald’s top line performance.

Closures To Affect The Company’s Top Line Performance

For the last two years, growth in the European region is primarily driven by positive comparable sales in the U.K. and Russia, and partly by expansion in Russia. In 2013, McDonald’s reported net revenues of $28 billion, with Europe being the biggest contributor (40% of the total sales). Russia, along with Germany, France and the United Kingdom, accounted for 67% of Europe’s revenues in 2013. ^[5] Evidently, Russia has become an important operational market over the last five years, as the company believes that the country is one of its top seven major markets outside North America.

• Total Net Sales to Decline

The temporary closures are already hurting the company’s sales, as four of the five outlets were in the central Moscow region, which generally receive a huge daily footfall. Moreover, the outlet on Pushkin Square is the chain’s most frequently visited franchise in the world, according to the company’s website. The Pushkin Square outlet is estimated to serve over 40,000 people every single day. On an average, McDonald’s in Russia are twice as busy as those in the U.S., the brand’s biggest market. Russian outlets serve 850,000 visitors per year per restaurant, as compared to 400,000 in the U.S. ^[6]

Thus, we can estimate the revenue loss the company is facing for the past one week, with just temporary suspension of these restaurants. But, if the Russian court orders for permanent shutdown of these outlets, it might deliver a huge blow to McDonald’s annual revenues.

• Customer Traffic

Russian officials are citing sanitary reasons for the suspension of operations in these outlets. Analysts believe that this decision is influenced by the ongoing U.S.-Russia dispute over Ukraine and reactions of local people suggest that they believe the same. However, health concerns might force customers to shift to other options. The revenue from the customer traffic lost in the last week by these outlets will significantly impact the company’s quarterly performance. Moreover, the health safety issues have already witnessed a slight decline in other outlets in the Capital.

A permanent closure of outlets in the country might affect the system-wide average customer traffic of the company, eventually leading to a decline in net sales.

• Import Ban on Agricultural Products to Affect McDonald’s Operations

The Russian government has imposed a one-year ban on imports of agricultural products such as meat, fish, dairy products, fruits and vegetables from the U.S., the European Union, Canada and Australia – all countries levying sanctions on it. ^[7] However, some of these restrictions were removed last week to allow imports of vegetables. ^[8]

The import ban has created a lot of trouble for restaurants dependant on meat and meat products. Fast food restaurants such as McDonald’s and other local joints are facing problems regarding the availability of raw materials. Although most of it is available from the local suppliers, the ban has negatively affected McDonald’s operations in the country. The import ban will continue to create more significant problems, making it harder for the company to acquire raw materials.

Looking at the prevailing conditions in the region and the recent sluggish growth of the company, raising the menu prices is not a good option for McDonald’s. As a result, the company’s margins might shrink.

According to our estimates, the company-operated EBITDA margins in 2013 were 18.5% and might further drop down to 18.2%-18.3%.

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1. Russia is closing McDonald’s restaurants over health concerns [↩]
2. Meat scandal takes a bite out of McDonald’s sales in Japan [↩]
3. Putin bans agricultural imports from sanctioning countries for 1 year [↩]
4. McDonald’s Q2 2014: Earnings call transcript [↩]
5. McDonald’s earnings call transcript, Q4 2013 [↩]
6. Russian evolution, seen through Golden Arches [↩]
7. Ref: 3 [↩]
8. Russian watchdog shuts four McDonald’s restaurants in Moscow [↩]