No Respite For McDonald’s As Situation Worsens In Eastern Markets

The American fast food giant, McDonald’s Corporation (NYSE:MCD), had one of the most challenging periods last year, with several operational and financial headwinds affecting the company’s financial performance throughout the year. Despite the dominance of the Golden Arches in the fast food industry with 17% market share by value last year, the company has been facing stunted growth over the last few years. McDonald’s has been reporting a mere 2% average growth in revenues over the last two years, with a significant decline in comparable store sales. McDonald’s annual report for the fiscal 2014 is to be released later this month.

We have a $96 price estimate for McDonald’s, which is roughly 4% above the current market price.

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Everyone is speculating about another disappointing yearly performance by the company, expecting a further deteriorating result this time primarily due to three major reasons:

Increasing Competition In The Industry

The decline in customer traffic due to stiff competition among the quick service restaurants (QSRs) for the breakfast market, hurt the company’s comparable sales growth for the entire year. Fast casual restaurants are stealing the already diminished customer traffic, as customers gradually drift away from fast food dining habits to healthier options. According to Technomic’s report, the fast casual segment witnessed an 8% increase in the comparable store sales in the third quarter of fiscal 2014, compared to 1.9% and 1.2% for casual-dining and QSRs respectively. ^[1] The report also mentioned that the consumers, with job growth and more disposable income, are more likely to spend their extra cash by trading up from fast casual restaurants to casual dining outlets for higher quality food, rather than going to cheaper alternatives – such as fast food chains.

McDonald’s Asian Markets: Another Issue Threatens Progress

McDonald’s struggled a lot in its Asian markets in 2014, primarily due to the Chinese meat supplier scandal and its impact on the company’s performance in China and Japan. (See McDonald’s Faces Declining Sales In Asia After China Food Scandal) As a result, in August, McDonald’s reported that its global sales for the month of July dropped 2.5%, with a 7.3% drop in the APMEA segment. ^[2] Moreover, the company’s global comparable sales declined 3.3% y-o-y in Q3, primarily due to a decline in customer traffic and headwinds in the eastern markets. The company operates over 2,000 restaurants in China, of which most stores in Northern and Central China witnessed plummeting sales due to the unavailability of beef and chicken products, whereas restaurants in Southern China were unaffected. The scandal has built a negative reputation among the Chinese customers, leading to a drastic decline in customer count.

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.  McDonald’s stores in Japan, the company’s second biggest market, have suspended their 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 net income and a 4% decline in sales for the six-months ended June 2014, due to store closures. ^[3] According to McDonald’s November sales report, the company’s comparable store sales declined 2.2% year-over-year in November 2014, with the comparable store sales down 4% in Asia/Pacific, Middle East, and Africa (APMEA). ^[4]

Although in the last couple of months the company’s Asian units have been trying to restore  consumer confidence and it seemed that it might take another 3-4 months for the company to see any major change in the financial results in these regions. Before the burger giant could stabilize, however, another issue halted its progress. In the first week of January 2015, there were reports that a piece of vinyl was found in the chicken nuggets at one of the outlets in Aomori, Japan. ^[5] The company’s Japan units started getting meat supply from three plants in Thailand, after the Shanghai Husi group was accused in the China meat scandal. The contaminated food material was taken over to the company’s headquarters in Tokyo for investigation. This issue might not only result in a sharp decline in sales for the company in Japan, but might also hamper the company’s effort in restoring overall consumer confidence.

Headwinds 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. ^[6] 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 that country. The decision on the affected stores in still pending and before the company could take any counter measures; the economic conditions in the country forced the company to raise prices of some of its popular food items. The Russian Ruble depreciated from 45 RUB per 1 USD in November, to 74 RUB per 1 USD in December, forcing the international brands to hike prices. As a result, McDonald’s raised the price of the Big Mac by 2.2% to 94 Rubles ($1.77) in December, holding the economic conditions and rising costs of raw materials and electricity as the reason for the hike. ^[7] With no decisions on the shutdowns of the company’s outlets in the country and declining customer traffic in the country, a price hike might further affect customer traffic.

All these issues and their impact point to another potentially disappointing annual result for the company. Moreover, the company not only has to come out with drastic measures soon, but also has to ensure their effectiveness, as other top fast food chains are gradually eroding away McDonald’s market share.

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1. 5 foodservice stats to toast at the close of 2014 [↩]
2. McDonald’s global sales drop amid China food scandal [↩]
3. Meat Scandal takes a bite out of McDonald’s sales in Japan [↩]
4. McDonald’s reports global comparable sales for November [↩]
5. McDonald’s Japan faces fresh problem with chicken nuggets [↩]
6. Russia is closing McDonald’s restaurants over health concerns [↩]
7. McDonald’s raises Russian Big Mac price amid plummeting Ruble [↩]