McDonald's Has a Huge Growth Problem—In the US

09/10/2014 5:40 pm EST

Focus: COMMODITIES

Jim Jubak

Founder and Editor, JubakPicks.com

The main hurdle facing this fast food giant here in the US seems to be growth, and while MoneyShow's Jim Jubak doesn't have a solution to the problem, what bothers him the most is that it seems like management doesn't have one either.

How does McDonald's (MCD) fix its problems?

Yesterday, September 9, McDonald's reported that same store sales for August fell by 3.7%. This marks the fourth straight monthly decline in same store sales.

I think that any potential solution has to begin with an understanding that the company faces two separate sets of problems. One will solve itself with time. The other is a much bigger long-term puzzle.

Problem one could be seen as a horrendous string of bad luck. McDonald's has been hit with a scandal over a meat supplier in China. Workers at supplier Shanghai Husi Food-a unit of OSI Group-have been charged with changing the expiration dates on meat. Not surprisingly, this has hurt sales. A drop in sales in China led a fall in comparable store sales of 14.5% in the Asia Pacific Middle East and Africa region. Yesterday, McDonald's said it expects that this problem will cut 15 cents to 20 cents a share off of third quarter earnings.

But that's not McDonald's only piece of bad luck. In retaliation for sanctions imposed by the United States and the European Union-in response to what has become a Russian invasion of Ukraine-Russian health regulators have ordered the temporary closure of McDonald's restaurants while they investigate claims of violation of sanitary rules. More than 100 restaurants are being inspected.

Both of these situations will be resolved by the passage of time. The Russian/Ukraine war will wind down. Chinese consumers will eventually be reassured by actions the company has taken to bolster its inspection of suppliers.

(It hasn't helped either that Europe, the company's second biggest market by sales, is in the midst of a near-recession. That too will end-someday.)

The second set of problems, however, is not so easily solved. McDonald's is seeing its core business in the United State slow. Comparable store sales in the United States fell 2.8% in August after a 3.2% decline in July.

Here the problems seem to include increased competition, especially in the breakfast market, and the increasing exhaustion of the low-price strategy. McDonald's has cut the price of 20 chicken McNuggets to $5, for example, in an effort to attract more traffic and in the hope that customers attracted to the restaurant will buy other menu items with bigger margins. Competitors have pursued the same strategy and that has resulted in a race to the bottom on prices that hasn't solved the basic problem of tepid demand growth in the fast food segment.

The worry for McDonald's and competitors is that the decline in US demand is permanent and that it is related to basic demographic or market trends. Perhaps an aging US population just isn't going to eat as many Big Macs. Perhaps there is a permanent move toward somewhat healthier, somewhat more carefully sourced food like that sold by Chipotle (CMG).

I don't have a ready solution for that second problem. What bothers me as investor is that I don't see convincing signs that McDonald's management has a solution either.

I can see McDonald's shares rebounding somewhat on an end to the bad luck in Russia, China, and the European Union. I don't see them moving much higher on a consistent basis without a solution to the problems of declining growth trends in core markets.

Full disclosure: I don't own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I managed, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund shut its doors at the end of May and my personal portfolio is now in cash. (Please don't read a market call into that cash position. It's simply taking time to wind down the management company behind the fund.) I anticipate putting those funds to work in the market over the next few months and when I do I'll disclose my positions here.

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