Don’t Dump MCD Stock Just Yet – McDonalds Has a Plan

by James Brumley | April 23, 2014 6:00 am

Don’t Dump MCD Stock Just Yet – McDonalds Has a Plan

It isn’t much of a stretch to suggest that McDonald’s (MCD[1]) has lost its way as a company, let alone a category leader. Last year was a miserable year for McDonald’s … in terms of sales, as well as earnings. Same store sales were up a mere 0.2% in 2013[2], while profits grew just 2% on a 2% uptick in company-wide sales. And earnings per share of MCD stock fared only a tad better, with a 4% increase in 2013.

McDonaldsPromo Don't Dump MCD Stock Just Yet   McDonalds Has a PlanBroadly speaking, things didn’t get much better last quarter. The company’s Q1 earnings report posted this morning indicated a 1.7% decline in U.S. same-store sales[3], and a troubling 4% decline in profits.

For CEO Don Thompson, who only took the helm in July of 2012 and made some pretty significant changes right out of the gate, it’s the kind of start that can leave a board wondering if they’ve got the right guy steering the ship.

Well, while it’s a bit premature to say McDonald’s is out of the woods yet, at the very least (and despite this morning’s news) it’s becoming clear that Thompson now “gets it.” The question is, can he actually do anything about it before it’s too late? The answer is probably yes, but that journey isn’t going to begin where most MCD stock owners are expecting to see it.

McDonald’s is Barking Up the Right Tree

If you’ve been in a domestic McDonald’s lately, there’s a decent chance you’ve seen a remodeled store. There’s an equally good chance you’ve gotten better, or at least faster, service. But if you think the company is focusing on its U.S. stores because that’s where the biggest opportunity for growth is, think again.

As it turns out, Don Thompson and his team see China as the most productive place to foster change … even if only because China is the only place they truly understand how to improve.

For those investors with a moderate knowledge of McDonald’s, it may be a disappointing decision to fix a market that less than 2000 stores currently call home, while the 14,000+ McDonald’s in the United States continue to miss the mark. A more intimate look at McDonald’s operation in China may uncover a good explanation for the foreign focus.

Take, for instance, the fact that the fast-food chain opened 225 restaurants in the United States last year, and aims to add another 250 domestic units this year[4]. Impressed? Don’t be. McDonald’s opened 275 units in China last year[5], and aims to open 300 new stores this year in China. It hopes to build another 2000 units there[6] by 2017. Translation: There’s more growth opportunity for MCD stock in China.

And to be fair, the company should be working harder in China.

For all the strides being taken to rekindle the relevance it enjoyed in the United States as recently as 2011, McDonald’s still doesn’t have a firm grip on its target market here. In China, however, it’s crystal clear who its customer is, what those customers are expecting from eateries, and what the company needs to do to fully capitalize on the opportunity.

In short, China’s middle class is still expanding like crazy[7]. A report published by McKinsey & Co. in 2012 calculated that the number of people in China that earned between $17,000 and $35,000 would grow from only 6% of the population in 2010 to more than 50% of China’s populace by 2020[8]. That’s a demographic right up McDonald’s alley.

Meet the New Chinese McDonald’s

And what exactly is McDonald’s doing to reframe itself in China, where it’s generally only found a lukewarm reception compared to its rival, Yum! Brands (YUM[9]) division KFC? First and foremost, it’s de-Westernizing its stores there.

Ten years ago, when China become a hotbed of growth for consumer-oriented American companies, the presumption was that the Chinese wanted a perfect recreation of the typical U.S. eating and shopping experience. Now, however, U.S. companies have learned (some the hard way) that there’s a limit to how much Western culture a Chinese consumer wants delivered[10] when inside a Western restaurant or retail establishment; there are still cultural aspects unique to China that are must-haves for anyone serving consumers there.

For McDonald’s, that means remodels and new-builds that incorporate Chinese — and even provincial — flare, like hanging lights and dynasty-era architecture[11]. It also means more food that’s familiar to the locals. Spring rolls and rice are finally on the menu at most of China’s McDonald’s, and much of the focus has been turned from beef and towards chicken or pork; beef is rarely part of the typical Chinese diet.

It’s not just the menu and the buildings’ ambiance that McDonald’s is retooling to attract China’s burgeoning middle class, however. A great deal of thought has gone into how that middle class thinks, acts, and dines, and the end result is the installation of large, round tables that can seat ten[12]. It’s something none of its American units would do because it would be waste of valuable floor space; we rarely eat as a party of ten, particularly at a fast-food restaurant. That’s not the case in China, however, where extended families are more apt to eat together. The large, round tables facilitate socialization during mealtime … a lost art in the U.S.

Bottom Line for MCD Stock

As for the investability of MCD stock, while it’s certainly disappointing that McDonald’s remains befuddled by American consumers, it may be worth considering the possibility that the average American consumer may be disinterested in Big Macs and McFlurrys and McCafes for reasons that go beyond the restaurants’ abilities to deliver a decent customer experience.

The reason for the struggle, however, is also moot. What fans and followers of MCD stock may want to appreciate is that McDonald’s is pretty close to hitting the nail on the head in a foreign market that’s going to serve up much more growth for the company than the United States could foster.

Although China isn’t likely to be the focal point of the company’s conference call, that doesn’t mean it’s not the critical growth spot for McDonald’s for the foreseeable future. As a modest piece of evidence to that end, while U.S. same-store sales were down 1.7% in the first quarter, same-store sales for the Asia-Pacific, Middle East, and Africa group were up 0.8% in Q1[13] — and Asia is the biggest piece of that pie. The numbers may feel small, but they underscore a very big trend that just may pull the company’s fat out of the fire.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

Endnotes:
  1. MCD: http://studio-5.financialcontent.com/investplace/quote?Symbol=MCD
  2. Same store sales were up a mere 0.2% in 2013: http://www.chicagobusiness.com/article/20140201/ISSUE01/302019985/can-china-rescue-mcdonalds
  3. 1.7% decline in U.S. same-store sales: http://www.forbes.com/sites/maggiemcgrath/2014/04/22/mcdonalds-first-quarter-profit-falls-as-u-s-same-store-sales-decline/?partner=yahootix
  4. aims to add another 250 domestic units this year: http://www.chicagotribune.com/business/breaking/chi-new-restaurants-us-2013-20140226,0,2834103.story
  5. opened 275 units in China last year: http://www.chinaretailnews.com/2014/04/21/7055-fast-growth-equals-more-fast-food-for-mcdonalds-in-china/
  6. hopes to build another 2000 units there: http://www.bizjournals.com/chicago/news/2014/04/18/mcdonald-s-china-revamp-to-include-imperial.html
  7. China’s middle class is still expanding like crazy: http://www.chicagobusiness.com/article/20140201/ISSUE01/302019985/can-china-rescue-mcdonalds#
  8. from only 6% of the population in 2010 to more than 50% of China’s populace by 2020: http://www.chinadaily.com.cn/china/2013-06/06/content_16573933.htm
  9. YUM: http://studio-5.financialcontent.com/investplace/quote?Symbol=YUM
  10. there’s a limit to how much Western culture a Chinese consumer wants delivered: http://investorplace.com/2013/12/american-retailers-in-china/
  11. dynasty-era architecture: http://www.bizjournals.com/chicago/news/2014/04/18/mcdonald-s-china-revamp-to-include-imperial.html
  12. installation of large, round tables that can seat ten: http://adage.com/article/global-news/mcdonald-s-a-local-touch-chinese-store-decor/292702/?utm_source=daily_email&utm_medium=newsletter&utm_campaign=adage&ttl=1398644898
  13. were up 0.8% in Q1: http://www.forbes.com/sites/maggiemcgrath/2014/04/22/mcdonalds-first-quarter-profit-falls-as-u-s-same-store-sales-decline/?partner=yahootix

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