McDonald’s emerging market growth strategy

This year is a much better one for emerging markets after a 2018 that investors in these markets may prefer to forget.

The MSCI Emerging Markets Index ended 2018 down 14.57%, but the rebound this year has been strong. The trade war between the U.S. and China seems to be evolving into an ongoing struggle with painful flare ups. Central banks are signaling that interest rate increases are on hold – and cuts may be coming. That has breathed new life into all markets.

The MSCI Emerging Markets Index is a good measure of the performance of the growth economies in Asia, the Far East, and Latin America. It captures large and mid-cap stocks in 24 emerging market countries, has more than 1,100 constituents, and covers about 85% of the stocks traded in each of the countries it covers. As of the time of writing (April 30), the index is up 35.89% year-to-date. The S&P/TSX Composite, by comparison, is 15.7% higher and Dow Jones Industrial Average is up by 14.17%

Here are three reasons why emerging markets will continue to have long run appeal.

 Fast growth: As these economies mature they will continue to expand at a much faster pace than ours. This growth is an unstoppable force. They have a young demographic and rising incomes. We have an older demographic with slowing growth and consumption.

Emerging economies have contributed more than 80% of global growth since the 2008 financial crisis. The World Bank sees EMs growing by an average 4.2% in 2019. Within that, the Big 3 – China, India, and Indonesia – are expected to fare much better, seeing growth of 7% (India), 6.2% (China), and 5.2% (Indonesia.) This is more than double or triple the 2% forecast for this country by The Conference Board of Canada.

Those numbers explain why the Canada Pension Plan Investment Board plans to have 33% of its assets, or if you prefer, your retirement hopes, in emerging markets by 2025.

 U.S. dollar relief: Canadians don’t need a reminder about the impact of a strong U.S. dollar. In emerging markets, it is even more pronounced. The dollar is the funding currency of choice and these economies have a huge need for cash to build roads, airports, power plants, and to expand factories and manufacturing.

Nobody can predict where exchange rates will be but after a long run, if the U.S. dollar weakens a little, the cost of serving the debt drops. This reduces the risk premium on EM equities, which may boost share prices. On the plus side, if the dollar stays strong exports tend to rise as the products become cheaper in local currency terms.

 Trade standoff: Trade wars are not good or easy to win. Neither China nor the U.S. has enough leverage over the other to impose its will. So, the relationship may well be one of managed struggle and intermittent crisis. As investors accept this new reality, they will build it into their assumptions and it may help ease volatility. (IWB associate publisher Richard Croft offered timely insights in the March 25 edition.)

McDonald’s is an example of a multinational taking advantage of emerging market opportunities. As economic energy migrates east, it is shifting its businesses along with it. Strength in these markets is offsetting weakness at home, helping the fast food chain increase its  dividend in the past year.

McDonald’s (NYSE: MCD)  

Background: McDonald’s has more than 37,000 outlets in 120 countries, of which 44% are in Asia notably China and South Korea, or other high growth countries like Poland and Russia.

Although best known for its hamburgers, McDonald’s serves a wide variety of food which it adapts to local needs and tastes. In coffee-crazy Australia, McDonald’s serves espresso and cappuccino with a robust flat white as its mainstay brew.  In India, the flagship sandwich is the Maharaja Big Mac, a meatless vegetarian (or chicken) version of the North American mainstay.

Performance: The shares of the world’s largest operator of fast-food restaurants are up 20.3% since last July. The stock hit an all-time high of $200 at the beginning of April before pulling back a little.

Recent developments: On Jan. 30, McDonald’s reported year-end results and warned of higher costs in the U.S. and Canada from labour, competitive pressure, and expenses related to remodeling stores. It also noted that a stronger U.S. dollar would weigh on 2019 earnings.

Its 2018 revenue of $21.03 billion was 18% higher year-over-year, with strong performance outside the U.S. and Canada. International same-store sales grew 4.4% in the fourth quarter, almost twice that of its 14,000 U.S. outlets.

The chain is introducing digital ordering kiosks in Canada and the U.S. along with mobile ordering and wider pay and pickup services. This replicates what works overseas.

Deliveries are now a $3-billion business. McDonald’s restaurants in Asia and the Middle East have offered delivery for many years, but the general rollout follows a successful 2017 test in Florida. This year, more than 10,000 restaurants, greater than one-in-four worldwide, offer delivery, with UberEats as its delivery partner.

 Dividend: McDonald’s is a dividend aristocrat. It has raised its dividend for 43 years in a row, most recently in November. The payment increased 14.9% to $1.16 per quarter ($4.64 per year). The stock yields 2.44% at current prices.

Outlook: The shares trade at 25.11 times McDonald’s projected 2019 earnings. That is high, but acceptable given the company’s dominant position and prospects.