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03/04/01 . Mary Ellen Podmolik . CNBC.com . US
Appetites Waning for McDonald's
McDonald's Corp. traditionally has been viewed by investors as a safe haven stock that could weather economic downturns. But no more. With fears of mad-cow disease and hoof-and-mouth disease sweeping Europe, investors have lost their appetite for the Illinois-based company and its 28,000 restaurants worldwide.
Shares of McDonald's are trading at around $26 a share, down 8 percent in just four weeks and 22 percent below where it was 13 weeks ago.
Don't look for real improvement anytime soon, restaurant analysts say, because McDonald's faces bigger issues than just sick livestock. "Can they adapt to the times?" asks John Glass, analyst at Deutsche Banc. Alex Brown. "They've done one thing very well for years, sell hamburgers cheap. Now they need to adapt to the times. People want variety and their lifestyles have changed. And no matter where you travel around the world, these issues are the same."
The imbroglio over tainted beef and the lingering sales slump surprised executives at McDonald's, the biggest buyer of beef worldwide. In mid-March, the fast-food giant lowered its 2001 earnings estimates to $1.55 from $1.61 a share, from previous guidance of $1.60 to $1.65. Executives said worries about European beef supplies "have persisted longer than we expected."
Few on Wall Street see any turnaround happening before the year's second half, and most analysts have cut their 2001 earnings projections below McDonald's guidance, to as little as $1.49 a share. In 2000, McDonald's earned $1.46 a share. Price targets also have been trimmed. For instance, Lehman Brothers trimmed its 52-week price target to $38 a share, from $42. JP Morgan Chase dropped its 2001 estimate to $1.49 a share, from $1.58, and its 52-week price target on the stock to $33 a share, from $35 previously.
Also, Moody's Investors Service revised the outlook for McDonald's debt ratings to "negative," from "stable." A ratings cut, if it occurred, would make it more expensive for McDonald's to borrow money.
"The mad-cow disease and the foot and mouth disease obviously have hurt sales but (they have) also highlighted the problems McDonald's has had with sales in Europe," says Tony Howard, an analyst with J.J.B. Hilliard, W.L. Lyons who has a "hold" rating on the stock. "Sales were slowing in Europe and this kind of exasperated the problems. It's also raised the cost of beef and pork."
Howard doesn't predict any growth for McDonald's until next year.
With the U.S. market already saturated with golden arches, the international markets had been viewed as McDonald's growth vehicle. Indeed, last year its international business accounted for 60 percent of its revenues and 52 percent of its annual operating profit. European restaurants alone contributed 33 percent of the corporation's operating profit.
Unfortunately, analysts say, problems overseas are diverting attention from improvements in the once-stagnant U.S. operation. Recent menu changes and the installation of a new "made for you" cooked-to-order production system have begun to foster modest same-store sales improvement.
"The company has an incredible brand franchise," notes Andrew Barish, an analyst at Bank of America Securities who has a "market perform" rating on the stock. "There are a lot of good things to talk about but the earnings numbers haven't been growing as expected. We need some better visibility on what's going to happen in Europe over the next three to six months."
At the same time, Barish notes McDonald's valuation is starting to look attractive compared to where it historically is, with a P/E ratio of 18 times earnings, compared with a historical P/E ratio of anywhere from 20 to 30 times earnings.
Last Thursday, First Union Securities Inc. upgraded McDonald's from "buy" to "strong buy."
Deutsche Banc.'s Glass has a "buy " rating on the stock, reasoning that if McDonald's begins to make fundamental changes in its business by introducing the "made for you" production system worldwide and offering diners more non-beef options, investors will see rewards - but not overnight.
"This is an oil tanker, not a speed boat," Glass says. "Things incrementally will get better. I wouldn't bet
against the company long, long term. But what's going to be required of the company in the next couple years
is different than what's been required of the company historically."