With Domestic Sales Slowing, Fast Food Players Carry Out International Expansion Plans

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By Jennifer Yousfi
Managing Editor

Fast food companies are feeling the squeeze.

On one hand, sales are growing in the emerging markets abroad. At the same time, however, the quick-service restaurants also are wrestling with a slowdown in their home U.S. market, and a backlash from media-fueled concerns about the spread of obesity.

In a saturated U.S. market, fast food firms have had to find a delicate balance between soaring raw ingredient prices and a penurious U.S. consumer who is increasingly feeling the pinch of high gasoline prices and a slowing U.S. economy.

Many of the names that have long been associated with the American market have turned to growing overseas markets to compensate for lagging domestic sales.

The Original, But Still the Best?

McDonald's Corp. (MCD) has been around for more than 50 years and, for better or worse, the company's familiar Golden Arches logo has become synonymous with America. With the purchase of the McDonald brothers' San Bernardino, California restaurant in 1954, the late Ray Kroc started a fast food powerhouse that now has over 31,000 restaurants in over 100 countries worldwide, which serve 56 million customers daily.

Unlike its rival, Yum! Brands Inc. (YUM), McDonald's has been going back to basics in recent years. It has divested controlling interests in its other brands, which once included Boston Market, Chipotle, Donatos Pizzeria and Fazoli's.

Revenue for full-year 2007 reached a record $22 billion on the back of a 6.8% increase in sales, but net income dropped to $2.4 billion from $3.5 billion the year before. Earnings per share also declined, dropping to $1.98 per share last year from $2.83 in 2006.

Sales in Europe and Asia, helped by a currency boost from the weak greenback, are outpacing U.S. growth, but McDonald's feels it is well positioned to face a downturn in the U.S. economy.

"We acknowledge that the general retail industry here seems to be impacted by the current economic environment," Chief Executive Officer Jim Skinner said during a fourth quarter earnings conference call. "Historically, though, McDonald's has not been as affected by a slowdown in consumer spending as other retailers because of our everyday affordability. We offer great value for the money and we have a convenience advantage."

In a bid to increase domestic market share – and to swallow some of the $60 billion spent on beverages every year – McDonald's will be expanding its specialty drink offerings in 2008. Through co-investment with franchisees, McDonald's restaurants will add smoothies, frappes, and a variety of other fountain and bottle beverages to its existing iced-coffee and sweet-tea offerings. There are even plans to go head to head with Starbucks Corp. (SBUX), by offering espresso drinks at a much lower price.

McDonald's has also been selected as the Official Restaurant of the Beijing 2008 Olympic Games. The fast food giant has plans to build four restaurants in Beijing that will cater to the athletes, the news media and spectators. McDonald's also will run a Champion Kids promotion to give 300 children a chance to attend the Olympic games.

McDonald's has done quite well in the past by targeting children in its advertising – offering kid-friendly finger foods, playgrounds inside its restaurant, and The Walt Disney Co. (DIS) movie toys in its ubiquitous Happy Meals. But the kid-friendly strategy has also received widespread criticism, given that childhood obesity has been on the rise for years.

McDonald's has tried to combat that image by offering healthier choices and smaller portions.  

More Than Just Burgers

If someone asked: What fast-food company is the world leader in terms of total restaurant locations? While most consumers would probably guess McDonald's, the actual leader is fast-food rival Yum! Brands Inc., with 34,000 locations.

Yum is the proprietor of such well-known brands as KFC, Pizza Hut, Taco Bell, Long John Silver's and A&W All-American Food Restaurants. Yum also has East Dawning, an Asian-markets chain operated by its Yum! Restaurants International (YRI) division.

For the full-year ended Dec. 29, operating profit growth in China and within YRI helped offset a 3% decline in the United States. In addition to its already strong overseas performance, favorable currency exchange rates helped to boost earnings per share (EPS) by an additional six cents.

As was the case with McDonald's, Yum! Brands' domestic-market performance was the weak spot in an otherwise strong earnings report. The increase in same-store sales open a year was not enough to boost operating profit, down 1% from the prior year, due to higher commodity and labor costs.

"In all candor, the best thing I can say about our weak U.S. performance in 2007 is that it sets us up for growth in 2008," President and CEO David C. Novak said.

Yum has done exceptionally well in China, where most consumers think of KFC when they think of chicken. But now the company is planning to expand further into India, which hasn't proven to be a successful market for rival McDonald's, whose cash flows finally broke even in 2007, 17 years after opening it's first Indian locations.

Yum plans to open several Taco Bell locations in India in the latter half of 2008. India's Economic Times reported that Yum, which already has KFC and Pizza Hut locations in India, plans to double its revenues from India in the next three years, with most of this growth coming from Taco Bell.

Yum also has been pushing to increase domestic sales by revamping U.S. menus, increasing breakfast options, and reducing company ownership through a re-franchising program of its KFC and Pizza Hut brands, The Associated Press reported. And it looks like that hard work is starting to pay off.

UBS AG (UBS) recently upgraded Yum shares to a "Buy" from "Neutral." In a note to clients, analyst David Palmer said that "while some investors have expressed concerns that the U.S. re-franchising appeared to slow versus company guidance in 2007, we expect to see that trend reverse in 2008 and 2009."

"We believe the end result for Yum will be a faster-growing, more-international, higher-return company by 2010 – with 40% or more of its enterprise value coming from its rapidly growing China business," Palmer added.

Rounding Out the Pack

Burger King Holdings Inc. (BKC) and Wendy's International (WEN) are the No. 2 and No. 3 American hamburger chains behind McDonald's.

Burger King has more than 11,000 locations in 69 countries and Wendy's boasts more than 6,500 locations in 20 countries and territories. While neither fast food firm has made the big push into the foreign markets that larger rivals McDonald's and Yum have engineered, the two junior partners are facing the same domestic challenges – soaring prices and rising labor costs.

Despite these setbacks, Burger King has been able to post strong same-store domestic sales gains. For the quarter-ended Dec. 31, the firm's second fiscal quarter of 2007, Miami-based Burger King reported $49 million in net income, up from $38 million in the first quarter.

Total revenue increased 10% to reach $613 million on the strength of a 4.5% sales increase in stores open at least a year in the United States and Canada, a sharp contrast to the declining domestic results posted by McDonald's and Yum. And the company's outlook for the rest of the fiscal year is strong.

"The momentum is expected to remain throughout the second half of the year as we continue to promote our value menu and premium products, satisfying both cost-conscious consumers and guests seeking indulgence," CEO John Chidsey said.

Wendy's outlook, however, isn't quite so bullish. The hamburger chain that is known for using fresh meat – never frozen – has been under increasing pressure from key investor Nelson Peltz to either boost profits or expect a takeover.

Peltz, non-executive chairman of holding company Triarc Companies Inc. (TRY), owns the Arby's restaurant chain and has offered to add Wendy's to his holdings.  Peltz already controls about 9.8% of Wendy's outstanding shares and has made moves to try to take over the board of directors and remove Chief Executive Officer Kerrii B. Anderson

The company has struggled to find a successful advertising campaign since the death of founder Dave Thomas in 2002, but executives hope that a menu overhaul will supercharge customer traffic, which has been in decline for the past five years.

 "We have to grow the top line," Anderson told Reuters in an interview at the company's headquarters, referring to sales. "We are very focused on driving traffic."

With the current board in turmoil and pressure from Peltz, Anderson can't embark upon an aggressive international expansion initiative or a domestic re-franchising strategy right now. However, the company does plan to make some menu changes, including introducing a spicy version of the popular Baconator sandwich to appeal to men, while offering value-priced chicken wraps to appeal to female customers.

News and Related Story Links:

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