The market gets what the market wants and, for the first quarter of 2013, the market has wanted relatively (as compared to treasuries) high yield ‘defensives.’ I use inverted commas because when looking at a stock like McDonald’s Corporation (NYSE:MCD) I’m not convinced it is as attractive as the market thinks it is. Furthermore, if you buy a stock because it is fashionable then you better be prepared for any disappointment should fashion change.
It’s been a tough year for the fast food sector, and McDonald’s Corporation (NYSE:MCD) delivered another quarter of disappointing same store sales growth. Moreover, it described the informal eating out industry as being flat or declining in many parts of the world. So where did it all go wrong? Wasn’t this supposed to be the great defensive stock that proved itself so well in the last recession?
My take on this is that the 2008-09 recession certainly resulted in a significant amount of global unemployment and income insecurity, which fed through into consumers trading down and adjusting their behavior by dining out in cheaper outlets. Such conditions played perfectly into the hands of companies like McDonald’s Corporation (NYSE:MCD) and Yum! Brands, Inc. (NYSE:YUM). In addition they had growth opportunities in expansion into China.
Fast forward into 2012 and the trading down has run its course and suddenly comparables are getting a lot harder. The easy growth has gone and the challenges are building. Sales growth from China is slowing, and McDonald’s Corporation (NYSE:MCD) is having problems adjusting its menu to deal with the slowdown in Europe. I discussed some of these issues at the start of the year.
A look at its global comparable sales growth for the last few years.
Spot the slowdown?
Market Share Gains
While recognizing that the US market is tough, McDonald’s Corporation (NYSE:MCD) spent a lot of time trying to convince investors that it was gaining market share in the US. The idea is that the key to its long term growth would be the retention of market share and not necessarily margin or cash flow growth. It’s hard not to think that this is going to have an effect on Yum! Brands, Inc. (NYSE:YUM) and Burger King Holdings, Inc. (NYSE:BKW) in the US.
But this isn’t just about the US. The optics in China are becoming cloudy thanks to a combination of the chicken supply problem at Yum! Brands, Inc. (NYSE:YUM)’s subsidiary, KFC, and a later outbreak of Avian flu. All of which has caused issues for the rest of the fast food outlets in China. While this is causing some to believe that there is an inbuilt opportunity to bounce back in the second half of 2013, I’m not so sure. If you look at the chart above, McDonald’s Corporation (NYSE:MCD) APMEA growth was slowing well before these issues kicked in. Indeed, it was a similar story with Yum, so this isn’t just a story of some temporary weakness.
So even while China’s performance is uncertain, there is no let up in investment with McDonald’s planning to open hundreds of restaurants in China in 2013. Similarly Burger King Holdings, Inc. (NYSE:BKW) wants to open 1,000 stores in China within the next seven years, and the country is the focal point of Yum! Brands, Inc. (NYSE:YUM)’s growth plans. Obviously these companies wont adjust their long term strategic plans based on some temporary weakness, but might it prove a longer term issue?
As for Europe, despite previous efforts to take action in France and Germany conditions remain weak in Europe, and macro challenges in Southern Europe mean that growth will be hard to come by. Only the UK and Russia are performing in a manner that McDonald’s can be happy with.
Where Next for McDonald’s?
I think this is going to be a tough year for the company. Commodity costs are only forecast to go up 1.5-2.5%, but the real driver of earnings growth will be sales growth. Given that the stated strategy is to preserve or gain market share, it is hard to see any significant margin expansion this year. There is a lot of uncertainty with China, Europe remains in difficulty, and the US is becoming increasingly competitive. In conclusion it is hard to make the case that McDonald’s is the kind of defensive play that investors should be chasing, and if the market loses its fixation with yield then it might not be so well supported.
The article Why This Fast Food Play Is Facing a Tough Year originally appeared on Fool.com and is written by Lee Samaha.
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