It seems like a fantastic idea for McDonald’s Corporation (MCD) to expand its footprint. After all, bigger is better (and more profitable), so the value of McDonald’s stock is poised to improve, right? Not so fast. The flipside could give MCD stock holders stomach cramps.
Let’s be frank, even as the world’s biggest restaurant chain, McDonald’s has a myriad of operational problems to solve before it takes a shot at more restaurants.
Even without its vulnerabilities, opening over a thousand new restaurants in China is essentially taking a huge bet on a market that’s notoriously tough to penetrate.
Maybe the announcement doesn’t bode well for the McDonald’s stock price after all.
McDonald’s Embraces China … Too Tightly
The company confirmed rumors this morning that it will open 1,300 new restaurants in China over the next five years. CEO Steve Easterbrook is also looking to add a few more units in Asia, but in locales just outside of China.
If history is any indication, McDonald’s would build and operate its own stores to make such an expansion; footing the development bill, but reaping all the benefits of ownership.
Easterbrook pointed out that this time, however, it would rely on franchisees to burden the bulk of the cost. Although it ultimately means less revenue, it also means less capital is required and less risk is assumed.
These expansion plans sound understably tasty to anyone who has patiently held McDonald’s stock through its rough patch. So I’m sorry that I’m about to throw a fistful of salt into that plan.
Easier Said Than Done for MCD
The plan sounds enticing, if not necessarily plausible, for a several reasons.
If McDonald’s hopes to attract franchisees in China using agreements akin to the ones U.S. operators get, it may find few takers. In simpler terms, McDonald’s has very nearly pushed too many of its domestic partners out of business.
While only the most extreme of the horror stories manage to circulate, where there’s smoke, there’s fire. That’s why chatter of mandated-but-unaffordable spending by franchisees should be of concern — U.S. franchisees are rebelling. Chinese franchisees won’t walk into that same fiscal quicksand so eagerly.
Even beyond balking partners, however, McDonald’s may learn the hard way that it’s lucky the 2,200 units already up-and-running in China are still viable. See, while Chinese consumers love (some) Western brands, they also have long-term memories, and readily associate similar Western companies with one another.
Yes, that’s a direct jab at Yum! Brands, Inc. (YUM), which operates KFC restaurants in China. Though it happened in 2014, the impact of food-safety gaffe is still taking a toll more than a year later. It wasn’t just Yum!, though. McDonald’s also tainted its own reputation by serving tainted meat in China in 2014.
Now the company is not only asking those consumers to come back as if it had never happened, it’s asking those consumers to support 1,300 more restaurants. Chinese consumers aren’t quite as quick to forgive and forget as U.S. consumers are, however.
Even without the recent spate of food-related gaffes keeping would-be customers away, some U.S. companies have learned (the hard way) that China’s appreciation and curiosity for Western brands doesn’t inherently mean they want to regularly patronize those businesses.
Just ask Best Buy Co Inc (BBY), which triumphantly marched into China in 2006, expecting to take over the nation’s burgeoning love for electronics. By 2011 it was shutting down its Chinese stores, tail tucked between its legs.
It turns out Chinese consumers love electronics. They just didn’t like the look and feel of Best Buy’s very-Americanized big box stores.
If McDonald’s is to have any further success in China — and that’s a big “if” — it would be well-advised to take a cue from Starbucks Corporation (SBUX), which has adapted its business model, menu and ambience to meet the innate desire of Chinese consumers, rather than impose Western norms and Western food/drink selections.
As owners of McDonald’s stock know all too well, though, the company isn’t a fan of change, nor does it handle change well here in the United States.
It’s unlikely things would be radically different with China’s new restaurants.
Bottom Line for McDonald’s Stock
None of this is to say McDonald’s won’t be able to get the targeted 1,300 units in China up and running within the planned five-year timeframe. They may even become fiscally viable. It is to say, however, game-changing success is unlikely.
If a planned expansion in China is the only reason you’re willing to step into, or hold onto, MCD, you may want to keep looking for a better reason.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
