Mc Sell

It's been a tough week for McDonald's following the meat scandal in China which Sasha covered on Monday and then they released a disappointing set of second quarter results yesterday. Global comparable sales were flat, revenues were up 1%, operating income was flat and diluted earnings per share increased 1% on the back of share buybacks. This equated to $1.39bn or $1.40 a share. This is still a big and profitable business even though there is not much growth.


The biggest question to ask of course is why are sales flat? Is it an issue from the company or are consumers in general staying away from fast foods? From the surveys I have read and judging from the commentary from management the company has lost a certain amount of relevance with consumers. In fact I found this US burger survey the other day titled Best and worst fast-food restaurants in America. As you can see from the image below McDonald's burgers got the worst rating out of the whole bunch.





The survey which covered 96208 meals at 65 different chains went on to say the following. "Americans are spending more than ever to dine out-topping $680 billion per year (South African GDP is around 385 billion Dollars). And they are demanding more for their money, higher-quality fast food, and greater variety than can be found at titans such as Burger King, KFC, and McDonald's."


It makes sense. The first movers in fast food have been caught up and now quality is more important. Fast quality is what is required. Although McDonald's can tinker with their menu, their unique taste is what defines them. Innovation of the menu is extremely important and it seems like management have fallen off the ball somewhat.


Don't get me wrong, McDonald's is an amazing business with a very special history and I have no doubt they will come up with solutions to change consumer perceptions of them versus their competitors. My biggest concern about this business however is something a lot more serious and which is mostly outside of McDonald's hands.


Peoples awareness of a healthy lifestyle has never been higher. Heart disease is by far the biggest killer in the US and there are big campaigns to eradicate this. A healthy and fit lifestyle means you live longer, feel better and sometimes more importantly to some, you look better. Unfortunately McDonald's find themselves at the forefront of this issue with lots of negative press.


The reason we liked McDonald's in the first place was because we love the theme of fast convenient dining, especially in developing markets. That theme is not going away and I still strongly believe in the thesis. But the world is changing in the way it views food. Calories, protein content, Tim Noakes, carbohydrates and many other dietary related terms are being thrown around more and more. It's certainly rife in this office. Maybe this issue is not as prominent in developing markets but the bulk of McDonald's sales still come from the US and Europe.


So to answer the question above, the issues McDonald's are facing are coming from both internal and external factors. The stock trades at 17 times this years expected earnings and sales are expected to be slow to flat for the next couple of years. Not cheap with no growth.


In light of all that has been mentioned above we advise you to sell this stock. As mentioned above, we still really like the theme but we see Starbucks as a much better entry. Their food and juice offerings are healthier and coffee is receiving more and more positive reports from health surveys. They are also coming off a much lower base. If you already have Starbucks, a healthcare stock or even Nike would be a good swap. Both these stocks will benefit from the negatives facing McDonald's.