McDonald's (MCD)

[HenryTo]

Please read our latest mid-week commentary regarding the development of the highway system in China before reading the following. Also note that McDonald's and fast food in general really took off after the development of the highway system in the U.S. - not to mention the rising middle class as many of them bought automobiles and went on road trips. The following development (article courtesy of Bullmarket.com) - assuming the partnership pans out - is HUGE for MCD.
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McDonald's Takes the Fast Lane to Restaurant Growth in China
Thursday June 22, 10:25 am ET
Peter Topolewski, BullMarket.com

Like Starbucks (Nasdaq: SBUX - News), fast-food giant McDonald's (NYSE: MCD - News) sees tremendous opportunity in China, a land of more than one billion potential consumers. And like Starbucks -- which envisions China one day becoming its #2 market behind the U.S. -- McDonald's has expanded cautiously as it tries to find a balance between growth and finding the right employees, menus, promos, and locations. Things haven't been going especially well for McDonald's, however, as rival Yum Brands (NYSE: YUM - News) has more than 2x the locations (led by its KFC unit) and has grabbed market share over the past couple of years. With the 2008 Summer Olympics in Beijing just two years away, the company is intent on putting its Chinese operations on a growth trajectory, since it is a major sponsor of the Beijing games. Today it announced a deal that's aimed at helping it achieve this goal.

McDonald's announced that it will place drive-through restaurants at China Petroleum & Chemical (NYSE: SNP - News) gas stations. State-owned Sinopec, as it is known, is the largest gas retailer in the country with about 30,000 locations. The firms didn't offer a lot of details on the agreement, but it is clear from information given in various interviews that McDonald's isn't about to have 30,000 new restaurants any time soon. Currently with 760 in China, McDonald's hopes to have 1,000 by 2008 (compared to 1,600 KFC outlets). The company expects more than half of its new restaurants will be drive-through outlets, joining the three it has opened in China since December.

There's plenty to like about this move. The first is the company's choice of partner. By teaming up with Sinopec, McDonald's has overcome one of the largest hurdles facing foreign companies eager to expand in China: real estate. Starbucks has emphasized that location is a key to its success in the country, and it appropriately takes great care in choosing where to add stores. For Yum, meanwhile, availability has been a bigger issue, especially when it came to exploring the drive-through market. In Sinopec, McDonald's has a built-in inventory of 30,000 locations in urban, suburban, and rural locations to choose from.

The drive-though theme is no accident, as the deal is very much focused on the country's surging interest in cars. With sales in what are known as second- and third-tier cities now catching on in a big way, China is in the midst of an auto boom. Car sales last year nearly matched those in Japan. Although the sales growth rates in the industry have cooled from the 35% pace in 2003, the auto industry has a lot of growth yet ahead, as only eight out of every 1,000 Chinese own a car, versus 900 of every 1,000 Americans. Domestic sales are expected to approach nearly nine million annually by 2010. Sinopec is keeping pace by adding about 500 new stations a year.

The small percentage of car owners in China makes car ownership a striking status symbol, something McDonald's can appeal to with its drive-through stores, at least in the early stages of the boom. Keeping people in their cars to pick up and eat food could be a great "in" for the company, as Chinese currently very much prefer to dine in at restaurants. The quick "in and out" service of a drive-through could also appeal to another growing phenomenon in China, the rushed business person (which carries its own status symbol element).

For all these positives, the drive-through expansion isn't necessarily going to be a Sunday drive, however. Rival Yum has been slow to advance the model since opening the first drive-through in the country in 2002. Sales at drive-through KFC stores haven't lived up to expectations.

Since then it seems that times have changed, and perhaps the McDonald's approach just works better. The company has launched major initiatives that aim at making the stores a place to stop, relax, eat, and surf the Web. That's not necessarily dichotomous to the drive-through growth plan on tap in China. If done right, each approach can win over the different sets of would-be customers. The formula has worked remarkably well in the U.S. Although it's dangerous to simply transplant a winning formula in one country to others, McDonald's is smart enough to take the seed of a successful idea and build around it appropriately for local conditions. So far, the early returns from its three drive-throughs in operation in China have been encouraging. The firm said that drive-through customers generate about 30% of sales at the three stores that have the car friendly feature. That's well below the 60% rate at U.S. stores, but a strong showing for a country with far fewer drivers and whose diners are known to prefer eating in. Already, the company has said that sales at Chinese drive-throughs are higher than at the average store in the country.

Nonetheless, the Sinopec deal is about more than drive-throughs, believe it or not. Sinopec stations are and will be increasingly located along the country's network of freeways and highways, which are being built out in one of the largest transportation projects in world. Cars and trucks pull into these stations, but so do buses, which are becoming a more popular form of travel as roads improve. The buses don't stop for gas most of the time, but they stop to give passengers a break. One busload of passengers is the equivalent of about a dozen cars, and at these popular freeway rest stops, most of the passengers are looking for something to eat. With Sinopec, McDonald's has an opportunity to satisfy that hunger throughout the country.

The potential payoff from this pact with Sinopec won't be rolling in a few weeks from now, but if executed successfully, the payoff will be rolling in for years, as Sinopec's 30,000 stations provide a very long runway for store expansion in China -- enough to make China the company's #2 market in the years ahead. In fact, this could be one of those deals that McDonald's shareholders look back upon many years down the road as a pivotal decision by the firm. We're not ready to declare success yet, but the potential is there, with little downside risk attached. That alone makes this an astute move by McDonald's. If the partnership works as well as it could, the deal with Sinopec will eventually look brilliant.

McDonald's and Starbucks are Bull Market Report Recommended List Stocks.

Peter Topolewski is the Managing Editor of The Bull Market Report. He does not have any long or short positions in any company mentioned. Indie Research has a disclosure policy.

About BullMarket.com: The Bull Market Report is a daily email newsletter focused on long-term growth, value, and income-generating investments. One of the longest-running online investment newsletters available, it provides unbiased research and actionable daily market commentary. Launched in 1997, its Recommended List of stocks has outperformed the S&P 500 since inception. Click here to start your free 14-day trial or call 1-888-278-5515.

[HenryTo]

Morningstar's latest commentary on McDonald's and other fast food restaurants:

http://news.morningstar.com/articlenet/article.aspx?id=267351

[nodoodahs]

Picking the coffee based on taste, I prefer MCD or BK to SBUX coffee. Heck, the "Bengal Traders" coffee at Exxon stations beats SBUX for taste, and one of my favorite "road trip" coffees is Waffle House.
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I haven’t seen a beatin’ like that since somebody stuck a banana in my pants and turned a monkey loose.

[rffrydr]

MickyDee did alright this last quarter--best in Europe in 15 years! Breakfast and premium coffee (?) boost it here (40% stores)

[rffrydr]

Hussman's rabbit foot--or how to manage a multi-billion portfolio and still make double-digit returns.

It's been awhile but my experience in Hong Kong was witness to much formal black and Armani. Definitely an upscale event. Re the Economist Big Mac index; they should eat one before concluding it's the same (can you say Sizzlean?) But then it's an upscale and formal place. Boarding a horse, now that's a Hong Kong luxury!

The hiway network is great but also, my experience in Kunming, there was no understanding that this was a place for cars--not people (or goats). There are no "Big-wheelers"--there are big small (military style) trucks, loaded to the brim, teetering, stalled behind motorized rickshaws filled with bricks. I imagine this "network" will take quite some time to really work.

Up until this year and $70/oil, 1.8litre and below vehicles were "excluded" from this picture.

As a handy experiment: try walking around a fwy turnpike or arterial here in US. You will see how perspective (including consumption habits) change--at speed!

ps McDonalds ranks most undervalued as of May 25 in "Big Mac Index" at -58percent. But how much is subsidized sourcing vs. currency? eg Hiway network.

[HenryTo]

Eating at MCD as a kid in Hong Kong was not a "luxury" per se - but the place was certainly associated with the middle to higher middle class much more so than the "lowest common denominator."

[nodoodahs]

Neat stuff, how a Micky Dee's drive through could signify "prestige" in one country while signifying the lowest common denominator, screaming rugrats, or clean handicap-equipped bathrooms in another. Just like David Hasselhoff is a big music star in Germany but is known as that Knight Rider / Baywatch dude here in the U.S.

BTW, SBUX is still on my watch list for shorting.
_________________
I haven’t seen a beatin’ like that since somebody stuck a banana in my pants and turned a monkey loose.