McDonald’s Prepares For Breakfast Battle Amid Uncertainties In Overseas Markets

The American fast food giant, McDonald’s Corporation (NYSE:MCD) is evidently facing the wrath of changing consumer trends, as people are choosing healthier alternatives over cheaper food options. The Golden Arches have been facing stunted growth over the last couple of years, as the company’s net revenues grew just 2% year-over-year (y-o-y) in 2013, compared to 6% y-o-y growth in 2010. The company recently released its third quarter earnings report on October 21, in which the company reported a 5% y-o-y decline in the consolidated revenues. Moreover, the company’s global comparable sales declined 3.3% y-o-y, primarily due to a decline in customer traffic and headwinds in the eastern markets. ^[1] In the U.S., the company’s biggest market, the comparable sales declined 3.3% y-o-y, driven by strong competitive activity in the restaurant industry for the breakfast market share, as well as stiff competition from the fast-casual restaurants.

McDonald’s recently reported a 0.5% y-o-y decline in global comparable store sales for the month of October. ^[2] According to geographical segments, the comparable sales were down 1% in the U.S., 0.7% in Europe, and 4.2% in Asia/Pacific, Middle East and Africa (APMEA). The negative impact of overseas issues in the eastern markets, coupled with stiff competition in the restaurant industry, is taking a toll on McDonald’s financial performance, as the company witnesses declining customer traffic and diminishing brand appeal. The issues in China, Japan, and Russia might take a lot of time to resolve, as gaining the trust and loyalty of customers is not an overnight job.  In this scenario, probably the only option left with McDonald’s is to sustain its customer traffic through its breakfast menu.

We have a $96 price estimate for McDonald’s, which is roughly the same as the current market price.

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Damage Control In Eastern Markets

• Reviving Brand Image In China & Japan

Soon after the China meat scandal of 2014, the Chinese government issued a ban on import and sales of products processed by Husi Food Group. (See McDonald’s Faces Declining Sales In Asia After China Food Scandal) As a result of the ban, sales of McDonald’s popular chicken nuggets and chicken fillets were suspended in many Shanghai branches. Moreover, this scandal also affected McDonald’s Japanese unit, as 20% of the meat for chicken items in McDonald’s Japan were supplied by the Husi Food Plant. The country’s McDonald’s stores have suspended its imports from China and are using substitutes such as Tofu and fish for their nuggets. Before this scandal, the company was already facing a hard time in Japan with McDonald’s Japan reporting a significant 60% year-over-year  (y-o-y) decline in the net income and 4% decline in sales for the six-months ended June 2014 period, due to store closures. ^[3]

Assuming the same annual revenue per store across all the stores worldwide and proportionately distributing the net revenues according to the number of restaurants, China and Japan together accounted for 10.5% of the company’s net revenues in 2013. ^[4] In the latest quarterly report, the company reported a 55% y-o-y decline in the net operating profits to $178 million in the APMEA region. Moreover, the decline in customer traffic in those regions indicates the negative impact of the meat scandal on the company’s brand image.

The company mentions that its China unit is diligently working to restore customer confidence to strengthen its financial conditions in that region. McDonald’s might introduce various lucrative value meals and other meat items to attract the fast food lovers. Moreover, the fast food chain might introduce customized and personalized meals with locally relevant ingredients, with contemporary inviting ambiance. However, with commodity inflation, lowering menu prices might hamper its margins, but the company might opt for this risky option in order to drive long term growth.

• No Respite In Russia

In August, Russia’s food safety agency ordered the temporary closure of several McDonald’s restaurants in Moscow and the Southern Stavropol region on claims of alleged sanitary violations. ^[5] However, experts are skeptical that the decision comes as a result of tense U.S.-Russian political ties. More than half of the McDonald’s stores in Russia, including the one in Pushkin Square, are facing the impact of this economic crossfire. As a result, the company’s operations are widely affected, potentially diminishing the revenue generation in the country.

The experts believe that this situation does not seem likely to resolve soon and might hamper the growth of the company in the fourth quarter too.

McCafe’s Expansion To boost Breakfast Revenue Growth

Breakfast is becoming the fastest growing daypart for the quick service restaurants (QSRs), with coffee being the vital menu item. All the top fast food chains have introduced new coffee flavors to expand their coffee portfolio. On August 19, Kraft Foods Group (NASDAQ:KRFT) announced its deal to expand the manufacture, marketing, and distribution of McDonald’s McCafe brand in the U.S., with effect from 2015. ^[6] Soon after this, Keurig Green Mountain (NASDAQ:GMCR) announced a multi-year licensing, manufacturing, and distribution deal with Kraft Food Group, under which coffee brands such as Maxwell House, Gevalia, Yuban, and McCafe will be served under Keurig branded K-Cups. This might boost the sales of McCafe brand, as coffee lovers who prefer convenient at-home coffee brewing rather than going to the stores, will be able to enjoy McDonald’s coffee brand at home.

Moreover, in September, McDonald’s announced the introduction of McCafe ground coffee in Canadian grocery and retail stores. ^[7] Considering the fact that McDonald’s coffee sales have increased 70% since the introduction of McCafe specialty coffees in 2009, McCafe is the company’s best bet to capture some breakfast market share, by attracting new customers in a country where retail prices are slightly higher. This, in turn, can give a boost to the company’s average spend per customer visit.

It will be interesting to watch the impact of this decision in the next earnings report, as the coffee war is getting stronger in North America.

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1. McDonald’s Q3 2014: Earnings call transcript [↩]
2. McDonald’s reports global comparable sales for October [↩]
3. Meat Scandal takes a bite out of McDonald’s sales in Japan [↩]
4. List of countries with McDonald’s restaurants [↩]
5. Russia is closing McDonald’s restaurants over health concerns [↩]
6. McDonald’s USA and Kraft Foods Group Bring McCafé Coffee to Retail Outlets Nationwide in 2015 [↩]
7. Amid coffee rivalry, McDonald’s Canada to sell java in grocery stores [↩]