· McDonald's Records Worst Decline in Same Store Sales in 10 Years
· Q3 Earnings Expected to Reduce Per Share Earnings by at Least $0.15
· McDonald's Chinese Meat Supplier Investigated for Tampering with Expiry Dates
Investors holding McDonald's Corporation (NYSE: NYSE:MCD) stocks were left with an unpleasant taste in their mouth following the release of recent earnings. Same store sales for August declined by 3.7%, down a further 1.2% from July. This worrying trend now has Mickey D's comps at its lowest levels in over 10 years. It should be pointed out that the less than flavorful performance of the world's largest restaurant chain was dragged down by weak performance in the Middle East, Africa and Asia. The latter region was hampered by supplier-related issues. In China, the company supplying McDonald's with its meat - OSI Group LLC - has been put under investigation owing to tampering with expiration dates on packaged meats. Once this issue was brought to the public's attention, demand for McDonald's products in China and across Asia dropped precipitously.
How important is Global Demand for McDonald's?
McDonald's features 35,000 restaurants around the world, including 14,200 locations in the US alone. This global foodservice retailer operates in 100 countries where it is responsible for employing 1.9 million people. According to 2013 financial reports from McDonald's, they serve 70 million people every day, their global comparable sales growth (2013 figures) was 0.2% and their EPS growth was 4%. In terms of regional contributions to the company's overall profitability, the following company operated figures and franchised figures were reported for 2013:
· USA - $8,851 million
· Europe - $11,300 million
· APMEA (Asia Pacific Middle East and Africa) - $6,477 million
· Other Countries and Corporate Revenues - $1,478 million
The total revenues for 2013 were reported as $28,106 million. Company-operated revenues accounted for $18,875 million and franchised revenues made up the remaining $9,231 million. During the course of the year, guest count performance dropped 1.9 percentage points, with Germany leading the decline in Europe and Japan leading the decline in Asia Pacific.
The US Market
Store sales figures for McDonald's outlets declined by a margin of 2.8% in August, in stark contrast to a growth rate of 0.2% for 2013. When compared to July figures, the August decline is 0.4% better. At home, McDonald's is coming under intense pressure as US consumers continue to move away from calorie-rich fried foods towards healthier alternatives like Pollo Loco (LOCO) and Panera (NASDAQ: PNRA). McDonald's is also fighting for the same pool of customers with Burger King Worldwide (BKW) which is offering steep discounts and many menu variations.
The Chinese Market
However, it is China that is a cause for concern for McDonald's in Q3 2014. As the world's second largest economy with GDP growth of 7%, China is a particularly big market for McDonald's. China's appetite for American fast food brands is equally voracious, but a highly publicized scandal has decreased demand significantly. One of McDonald's suppliers - Shanghai Husi Food Co - was found to be using old meat mixed with fresh meat, and even scraping meat off the factory floor to be used at McDonald's franchises across China. The region that suffered the most, in terms of revenues, was Asia/Pacific, Middle East and Africa (APMEA). The declines recorded in this region were 14.5%, almost double the July comparable restaurant sales growth figures.
The Russian Market
Across Russia, over 100 McDonald's franchises have come under scrutiny by inspectors. Safety regulators have been keeping a close eye on restaurants with reports of several being shuttered for violations of sanitary codes. The Russian Consumer Safety Agency (Rospotrebnadzor) has closed 12 McDonald's franchises since the 20th August, with more to follow. However, it is uncertain if the intense scrutiny is grounded on clear violations of sanitary codes or whether it is Moscow's tit-for-tat sanctions against Washington. Apparently, the CPA in Russia filed suit against McDonald's citing claims that McDonald's food contains more carbs and fat than is permissible in the country. Given McDonald's food-safety issues in China, there may well be some validity to Russian claims.
Projections for McDonald's Stock
Technical and fundamental analysis of McDonald's indicates that it's likely to get worse before it gets any better. McDonald's is the only component of the DJIA that has generated negative returns in the past year (down 6%). With slippage of over 10% between May and August, we appear to be far away from seeing this stock bottoming out. In terms of buy/sell/hold actions, it is clear that McDonald's is a sell at this time. Just recently McDonald's stock broke through the $94 support level, leaving no doubt that it will continue its declines. It appears as if the stock offers a 3% dividend yield which offers promise as an income-generating strategy, but for real value, earnings of x 16 will likely be more attractive to investors.
Market sentiment is definitely bearish on McDonald's as the stock failed to hold at the $94 level. It broke above the $100 ceiling, but was ultimately dragged down on the back of food safety concerns, minimum wage issues and stiff competition. Buyers are leaving this particular market en masse, with sellers dominating. By contrast, Jefferies considers this stock a 'hold.' This financial analysis firm was bearish on its earnings per share expectations (EPS) for 2015 and they're expecting an EPS of $1.42 for Q3 (down from $1.59 p/share). For 2014, Jefferies is expecting an EPS of $5.40 (down from $5.94).
Playing the Devil's Advocate
While McDonald's numbers are nothing to get excited about, the company has plenty of muscle in its marketing campaigns. Mickey D's has posted 3 quarters of negative growth, but it also delivered solid returns for almost 10 years before hitting a series of US and international obstacles. In terms of the minimum wage dispute, McDonald's could easily turn things around and increase the wages it pays to its workers, but these costs would have to be passed on to consumers in the form of higher prices. Since the company is big on technology, it could use that to its advantage by automating more work, and retaining fewer staff at higher wages. Also important to note is that McDonald's is big on payouts. Disbursements from the company can certainly grow. A recent announcement by the company pledged to return up to $20 billion to shareholders by 2017, through buybacks and shares. So perhaps these short term losses are a prelude to a higher stock price in the future.
