A Scenario That Can Impact McDonald’s Stock Price

McDonald’s Corporation (NYSE:MCD), the leader in the U.S. restaurant industry, has been struggling to retain its lost momentum over the past few months. The company’s situation worsened in 2014, as the Golden Arches were faced with many operational headwinds in almost all their geographical segments. On one hand, stiff competition in the U.S. negatively impacted the comparable store sales, whereas on the other hand meat supplier issues in China last year impacted McDonald’s China and Japan units. Both the issues respectively led to a decline in customer trust and therefore, customer traffic. To add fuel to the fire, the company’s temporary store shutdowns in Russia was further worsened by the struggling Russian economy, leading to harsh counter measures by the company, such as menu price hikes.

As a result, on January 28, the company’s Board of Directors announced the retirement of Don Thompson as President and CEO of McDonald’s, to be succeeded by Steve Easterbrook, the then chief brand officer and senior executive vice-president of the company, on March 1. ^[1] Soon after the announcement, the company’s stock (MCD) jumped 5.6%, the highest in the last 12 months, from $88 to $93. Don Thompson’s decision came as a result of the company’s sluggish performance over the last two years, especially in 2014, when the fast food leader faced challenges in all geographical segments.

We have a $96 price estimate for McDonald’s, which is in line with the current market price.

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While the Trefis estimate for the MCD stock is in-line with the current market price, we estimate the net revenues for fiscal 2015 to be roughly $28 billion, which is 10% above the general consensus, as well as expecting higher than expected expenses. ^[2]  However, taking the current market and industry trends, as well as probable future scenarios in mind, there is one scenario that can impact the company’s stock price.

• Headwinds in Asian and Russian Markets

As mentioned before, McDonald’s faced tough times last year in China, after the meat scandal came into light. 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 was followed by 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.

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. The issue led to a decline in the customer count in most of the branches in China and Japan, further resulting in a decline in comparable store sales in these regions. 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. 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 fiscal 2015.

Additionally, McDonald’s is facing the wrath of struggling economic conditions in Russia as well. The Russian Ruble has depreciated by more than 40% in the last 3 months. 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. Higher prices in such a poor economic condition might result in a drastic decline in customer count.

According to our estimates, the annual customer count per restaurant declined by 2.3%. However, looking at the recovery efforts, such as introducing new organic items, using new meat suppliers, and the introduction of the  ‘Create Your Taste’ burger platform, we estimate the customer traffic to increase by 0.5% to 0.8% in the next few years. Since the company is struggling with customer traffic, it cannot risk  raising its menu prices, despite the commodity inflation. As a result, we estimate the average check to remain flat for the next few years.

However, to regain the customer trust on a large scale is a long-term scenario and these issues came at a time when the commodity prices are on an uptrend and food companies are raising the menu prices. There are many catalysts that can negatively impact the company’s recovery efforts. Firstly, China and Japan are food loving nations, with many fast food brand substitutes, both local and international. Moreover, the meat scandal has directly hurt the customers’ trust in the hygiene and quality of the food prepared by McDonald’s. Regaining the trust of people in such markets, where people have many alternate options, would take a lot of time and investment. Secondly, there are no signs of any improvement in Russian economic situation, further worsening the predicament. Lastly, prices of beef and other meat products are expected to remain higher in 2015. This might force the company to raise its menu prices. However, any more price hikes might further hamper the company’s effort in improving the customer count. In such a scenario, McDonald’s might go without any price hikes, thus, compromising its margins.

The first two factors might directly impact the customer traffic negatively for the next 18-20 months. Considering that these three nations (China, Japan, and Russia) together have nearly 5,500 McDonald’s restaurants, the first two factors might contribute to a 1.5% decline in customer traffic for the next 1.5 to 2 years.

However, alternatively, if McDonald’s goes for menu price hikes, compromising the customer traffic, then the three factors might together account for a 2% decline in the customer traffic for the next two years. This would translate to an 8% downside to our price estimate. On the other hand, if the company tries to save the customer traffic decline and compromises its margins f0r the next 12 months, it would translate to a nearly 10% downside to our price estimate.

These possible realities are evidence of the corner that the company finds itself in. Perhaps the new CEO and a new strategic plan can revitalize the brand. However, the issues of declining traffic, regaining customer trust, and making their dining experience sizzle again, may take some time to accomplish.

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More Trefis Research

1. McDonald’s announces key management changes [↩]
2. Reuters: McDonald’s [↩]
3. McDonald’s China will continue to use scandal-ridden meat supplier OSI Group [↩]
4. McDonald’s Japan faces fresh problem with chicken nuggets [↩]