McDonald's aggressive plans for China
The fast-food giant hopes to catch up with KFC.
By Peter Pham
While McDonald's (MCD) has made great inroads in China, it is still not a dominant player there.
It has big plans, however, and hopes to expand the reach of its Golden Arches from the current 1,300 locations in the People's Republic to 2,000 by the end of 2013.
To accomplish this, the fast-food company will have to hire 70,000 people this year alone, nearly doubling its China workforce to open 250 locations. The lion's share of the expansion will happen in 2013.
Yum Brands' (YUM) KFC is the dominant player in China's quick-serve restaurant (QSR) sector. The company's management impressively adapted its business model to better suit China recently and it's in no danger of losing momentum. There is still plenty of opportunity for growth in China.
The QSR market in China grew by 14% in 2011, to $99 billion in sales. McDonald's performance in 2011 was even more impressive, with total revenue up 19% between both franchises and company-owned stores, which dominate their current business model. Same-store sales were up 5.5% year-over-year, with a 7% rise in net income for the Asia-Pacific region. But, so far in 2012, comps have struggled well below that level -- 2.4% in March and 3.3% in April, with Asia-Pacific, Middle East and Africa (APMEA) comps slowing to just 1.1%.
One of the advantages that KFC uncovered in its expansion in China is the importance of adapting menus to local tastes -- not just at a national level but regionally. In the U.S., KFC in Florida is pretty much the same as KFC in Seattle. It's one of the downsides of the franchise model as the menu is dictated by the corporate entity. Yum's Asian division, however, has retained a majority of company-owned stores, which actually helps to streamline constant menu changes and maintain communication with the locally trained employees, who respond to the whims of their customers. McDonald's customizes its menu slightly to Chinese tastes, but nothing like the regional tailoring of KFC.
McDonald's is also remodeling a number of its restaurants in China, adding wi-fi and other amenities to entice customers, as well as upping the number of locations with drive-thru service.
China accounted for 44% of Yum's global revenue in 2011 and that is likely to rise above 50% in 2012. McDonald's APMEA revenue rose from 18.6% to 22.3% of total revenue between 2009 and 2011. China, however, accounts for only 3% of McDonald's total profit.
Quality and integration
McDonald's faces serious challenges in China, not just from the further integration of KFC into the Chinese food culture but also from a quality perspective. Part of the allure of American-branded food is the perception that it is safe to eat. Food quality is a big issue in China and so it was especially unfortunate that McDonald's was at the center of not one but two incidents of serving expired food. This will not help the company's in its quest to play catch up with Yum.
With an operating income of $10 billion in 2011, McDonald's certainly has the money to build infrastructure in China and give it time to gestate. It's not clear, however, if it is building the kind of connection with the populous that it has in the U.S. and Europe. So, while the expansion in China, on first blush, looks very bullish for the stock, it may be hard for the company to realize strong bottom-line growth in the face of both higher labor costs and high commodity prices.
With the global macro picture deteriorating and the iShares FTSE China 25 ETF (FXI) in free fall and capable of shedding another 14% to the October 2011 lows near $29 per share, it would be premature to count on this expansion in China to support the stock price right now. McDonald's chart looks to have solid support in the low to mid $80's, if this consolidation between $90 and $92 per share fails along with the general market. A fall towards $82.50 -- which is very possible if the Fed delays much longer before announcing the next round of quantitative easing -- would imply a price-to-earnings ratio of 15.7 and a 3.4% dividend yield.
Peter Pham is an expert consultant in global equities with 12+ years experience in all aspects of capital markets. He has held senior positions at several brokerage and investment firms, working with some of the world's largest international funds.
More from Peter Pham
I always found KFC tastier than McD's. If you want to cook burger patties, you better have an open flame. If you don't, do burgers that don't require fire.
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