Weak Economy In Russia & Supplier Issue In China Drives Down McDonald’s Revenue Growth In 2014

McDonald’s Corporation (NYSE:MCD) released its annual figures for the fiscal 2014 year on January 23.  2014 was a challenging year for The Golden Arches, as some operational headwinds and issues in the Asian market pressured the company’s financial performance. For fiscal 2014, the company reported a 1% year-over-year (y-o-y) decline in comparable sales, due to a major decline in customer traffic. As a result, the company’s net revenues declined 2% y-o-y. Due to the China meat scandal in August, as well as weak performance in the U.S., the company’s operating income for the fiscal 2014 year declined 9% y-o-y.  McDonald’s reported a diluted EPS of $4.82, down 13% y-o-y. ^[1]

For the fourth quarter, the company reported a 0.9% y-o-y decline in the comparable store sales,  which resulted in a 7% y-o-y decline in net revenues. Diluted EPS for the fourth quarter were down 19% y-o-y to $1.13, primarily due to the supplier issue in China. The company expects its January comparable sales to be negative as well, due to the declining consumer confidence in Japan.

We have a $96 price estimate for McDonald’s, which is roughly 5% above the current market price.

See Our Complete Analysis For McDonald’s Corporation

Stiff Competition In The U.S.

In 2014, McDonald’s fell short of its guidance in its domestic market, due to strong competition in the restaurant industry for the breakfast market share. Over the last three years, the breakfast market has become a top priority for all the top quick service restaurants in the U.S.  Moreover, some of the fast casual restaurants, such as Chipotle Mexican Grill (NYSE:CMG), 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 comparable store sales in the third quarter of fiscal 2014, compared to 1.9% and 1.2% for casual-dining and QSRs respectively. ^[2] In this scenario, McDonald’s, who struggled the entire year, continues to witness a decline in customer traffic, whose impact might be visible in the future results as well.

As a result, in the U.S., the company’s Q4 comparable sales declined 1.7% y-o-y, whereas the operating income declined 15% y-o-y. In the fiscal 2014, operating income declined $257 million, or 7% y-o-y. Moreover, the company also mentioned that its U.S. results were also impacted by higher general and administrative spending.

McDonald’s has introduced new menu items and expanded its coffee portfolio in the U.S., to gain some share in the breakfast market. Also, the company has started an initiative — “Create Your Taste” in the U.S., in which customers  can personalize their burgers and other items with their own choices. This initiative is a part of the company’s strategy to make its business more customer-friendly, in order to increase the customer count. Moreover, this strategy might lift the sales of the classic burger items.

China Supplier Issue Takes A Toll On McDonald’s Annual Results

Probably one of the major turning points for McDonald’s in 2014 was its supplier issue in China and Japan. In July, Shanghai Husi Food, the company’s major meat supplier in China, was accused by Chinese authorities of using expired and contaminated meat products.  China, Japan, and Hong Kong were the most affected markets; and these markets collectively account for 10% of the company’s system-wide sales. However, McDonald’s decided to continue its 50-year long business with the food processing group by using a different plant, located in Thailand. ^[3] This issue led to a ban on import and sales of products processed by the Husi Food Group, resulting in the temporary ban on the sales of McDonald’s popular chicken nuggets and chicken fillets in many Shanghai branches. As a result, the company’s comparable store sales in the next 5 months witnessed a significant decline, as this scandal has built a negative reputation among Chinese customers, leading to a drastic decline in customer count.

Apart from this, the 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.

The company’s APMEA (Asia-Pacific, Middle East and Africa) segment witnessed a 4.8% y-o-y decline in the comparable store sales in Q4, whereas the operating income declined 44% y-o-y.  In Q4, China’s comparable store sales were -6.7%, however, the company mentions that the last three months showed improvements in the region, as a result of ongoing customer recovery efforts. In Japan and China, the company units are taking strategic steps to regain the lost brand trust and improve the customer count. The company is planning on strengthening its menu pipeline by including meals with local relevant ingredients, to appeal to local customers on a large scale. However, this issue might take time and thus, we can expect slower growth in the first half of 2015.

On the other hand, the recovery campaign in Japan has not been that effective. To add insult to injury, new issues have emerged in the country, as there were reports that a piece of vinyl was found in the chicken nuggets at one of the outlets in Aomori, Japan. ^[4]  McDonald’s Japan might take much more time to return to a normalized level. As a result, we can expect slower growth or even flatness in comparable sales in the first half of the fiscal 2015.

Russian Economic Situation Remains A Topic Of Concern

In the third quarter of fiscal 2014, McDonald’s 12 stores in Russia were temporarily shut-down on alleged claims of sanitary violations. Even though all of those stores are back in operation, Russia’s weakening economy has become a new concern and issue for international brands, including McDonald’s. Apart from depreciating Russian currency, rising costs of raw materials, and transportation charges, have forced the company to raise the price of its Big Mac by 2.2% to 94 Rubles ($1.77) in December.  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. ^[5] Europe’s commodity costs were up 1% in Q4 for the company, and relatively flat for the entire year.

All these  major headwinds have pressured the company’s margins in the last six months. As a result, the company has made adjustments to  its 2015 guidance, such as a  reduction in capital expenditure by trimming planned  new store openings in those markets that are facing short-term headwinds. The company’s  capital expenditure budget for fiscal 2015 is approximately $2 billion. McDonald’s plans to open more than 1,000 restaurants in the U.S., China, Russia, and France,  compared to 1,300 net openings in 2014. McDonald’s initiative to rebuild consumer trust in the brand, coupled with some operational strategies to protect the margins,  will remain the key to the company’s performance in 2015.

View Interactive Institutional Research (Powered by Trefis):

Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap

More Trefis Research

1. McDonald’s Q4 2014 earnings call transcript [↩]
2. 5 foodservice stats to toast at the close of 2014 [↩]
3. McDonald’s China will continue to use scandal-ridden meat supplier OSI Group [↩]
4. McDonald’s Japan faces fresh problem with chicken nuggets [↩]
5. McDonald’s raises Russian Big Mac price amid plummeting Ruble [↩]