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The story that MCD is currently conveying to the investment community is one of BIGGER, BETTER and FASTER; this is a very different tale from the story just a few years ago. 

It’s nice to get away from the office, especially given the pain being felt in the financial markets.  The opportunity that MCD and YUM have in China is a far cry from the euro zone debt crisis that appears to be spiraling out of control.  Given the issues that the Financial sector faces (and maybe Energy too) three stocks that look like “safe havens” over the longer term in the restaurant space are YUM, MCD and SBUX.

I would note that the leading story in the Shanghai Daily today was “China’s Local Lending Under Scrutiny.” While China’s debt/GDP is only 50% as compared to 100% for the US and 200% for Japan, the factors most likely to derail the growth story in China are primarily outside of the country's control.  Also in today’s paper was a story that according to the chief economist at the State Administration of Foreign Exchange, China’s GDP growth could be below 9% in 2012 for the first time in 10 years.  The article stated that “the weakening global demand for Chinese exports will be a challenge”.          

Forgetting the negative MACRO environment, the MCD presentation to the investment community today in Shanghai was about as bullish a presentation as any company could give.  Importantly, the numbers they are posting support the bullish story.  Clearly, the future is bright for MCD in China and throughout the rest of APMEA.

One of the stores we visited was in a more upscale neighborhood and right next to a Starbucks.  The McDonald’s was recently upgraded to a look that has a “European edge” to it.  McDonald’s term for the store is LIM - less is more.   The remodeled store has a McCafé in it selling its coffee/pastry products that are priced at roughly half of what Starbucks is charging for equivalent food and beverage items right next door.  The sales of McCafé products currently represent about 8% of sales.  It was pointed out to me that over the next three years that MCD will have 500 McCafé stores as compared to the current 470 Starbucks in China. 

I guess it comes as no surprise that SBUX announced yesterday that over the next four years the company plans to step up its expansion plans to triple the number of units in China.  SBUX now plans to operate 1,500 stores in China by 2015.  It would have been nice to hear from the Starbucks team on this trip to China.  Maybe over the next year or two the company will be in a better position to address the investment community in a more formal fashion.       

BIGGER - ACCELERATING UNIT GROWTH

MCD is well down the road of accelerating unit growth in China and hitting the target of having 2,000 units in the country by 2013.  As of June 30th, 2011, there were 1,349 units in China.  The unit growth strategy is based on the following principles:

  1. Accelerate the opening base - open more stores in the core markets (esp. the 5 most important cities) and helping to further make the core TV markets more efficient. 
  2. Portfolio mix - MCD will be looking to open 40% of the stores with a drive-thru and increase the number of stores in transportation hubs.  The increase in drive thru stores will help the company continue to drive same-store sales growth given the how the Chinese take to using drive-thru. 
  3. Customer experiences - modernize the store base and build more McCafe’s.      

BETTER - IMPROVING SALES TREANDS

McDonald’s average unit volumes in China have improved from $1.3 million in 2005 to $2.0 million over the last 12 months.  On an annual basis, the average store in China will serve 470,000 customers, and produce $200,000 in cash flow.  The average check right now is about $3 versus a little over $5 for the USA.

So far this year, same-store sales in China have been 10.5%, while traffic is up 8.7%.  The growth is being driven by (1) value, (2) breakfast and (3) opening more drive-thru stores.  I also learned that SSS in Shanghai have softened quarter-to-date, as they are now lapping strong sales from last year’s World Expo.

Over the next 2-3 years, MCD will be able to generate positive same-store sales as they open more drive-thru’s and they begin to gain scale on their remodel program.  A current store remodel is seeing a 6-10% lift in sales and when they include a McCafe in the remodel the sales lift approaches the low teens.

FASTER - HAVING THE RIGHT INFRASTRUCTURE TO GROW

The tough lessons of the past have taught the McDonald’s management to have in place a disciplined and efficient operating structure in China.  Over the last few years, MCD has optimized its asset base that now allows the company to accelerate unit growth in the coming years.  Importantly, the significant increase in average unit volumes now puts the concept on par with KFC when developers are looking to add one concept or the other to any given site.

On the margin, as MCD takes its real estate professionals from about 120 individuals today to 300 over the next few years, it will create a little more competition for YUM. 

Howard Penney

Managing Director

Rory Green

Analyst