What Investors Should Make of McDonald's Move

Who ever thought that ketchup could fuel a war? McDonald's (NYSE: MCD  ) recently announced its decision to end a 40-year long relationship with condiment manufacturer Heinz. This is nothing other than another battle in the ongoing burger wars between McDonald's and arch rival Burger King  (NYSE: BKW  ) .

Don't get the link? Here's some background.

The story so far
Earlier this year, Heinz was bought out by Warren Buffett's Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) and 3G Capital. Interestingly, 3G Capital also has a majority stake in Burger King, McDonald's closest competitor. Given the rivalry between McDonald's and Burger King, it is no wonder that McDonald's no longer wants to be associated with Heinz.

Heinz's loss
Heinz's $28 billion deal with Berkshire Hathaway was strongly supported by its management and shareholders. But little did they realize that it may cost them their long-standing relationship with the world's largest fast food company. According to the Wall Street Journal, McDonald's uses more that 250 million  pounds of ketchup per year in the US alone. Although McDonald's barely uses Heinz ketchup in the US (except in Pittsburgh and Minneapolis), it is still a huge customer for the ketchup company, as McDonald's uses Heinz ketchup almost everywhere else in the world. As of 2012, 59% of McDonald's 34,480 stores were located overseas. This clearly implies that Heinz's loss will not be negligible. As per the Wall Street Journal , Heinz has been trying hard to win McDonald's business for years, ever since a supply chain issue in the 1970's. It would thus be safe to conclude that McDonald's decision may significantly impact Heinz's global sales figures.

Silver linings
However, all is not lost for the world's biggest ketchup manufacturer. Under the new management following the takeover by Berkshire Hathaway, Heinz will be led by a superior team of executives, headed by Bernardo Hees , former CEO of Burger King. Known for superb leadership qualities, Hees and his team are widely accredited for Burger King's tremendous growth in the last couple of years. In fact, a major part of Burger King's growth occurred only after it was acquired by 3G Capital in a $4 billion deal in 2010. Under the new management , Burger King showed a 25.5%  jump in operating profit between 2010 and 2012. This was mainly achieved via successful cost cutting. During this time, Burger King's operating costs declined by a massive 28.6%. Menu expansion, celebrity endorsements and a new 'four pillar' strategy have also helped the company regain some foothold in the fast food industry.

Following the Berkshire Hathaway-Heinz deal, Burger King can look forward to a deeper relationship with Heinz, which already supplies ketchup to more than 80% of its stores. And Heinz can look forward to greater success and growth under its new management.

Who stands to gain?
As for business with McDonald's, Heinz's loss will be someone else's gain. The company that stands to gain the most is ConAgra Foods (NYSE: CAG  ) , which produces Hunt's ketchup, Heinz's nearest competitor. Another option for McDonald's could be Del Monte, which holds a much smaller market share. Over the years, ConAgra has been trying hard to win a greater market share in the US ketchup market. Ketchups and sauces constitute roughly 45% of ConAgra's net sales. Among the initiatives taken were launching an environment friendly bottle and a 100% naturally sweetened version. Currently, McDonald's mostly uses ketchup from Golden State Foods at stores in the US.

Wrapping it up
For McDonald's, finding a suitable replacement for Heinz may prove to be a bit of a hassle, given Heinz's market leader position in the global ketchup market. Heinz is highly preferred in European countries and McDonald's overseas customers may not take a switch to another brand very lightly. Nevertheless, McDonald's has not much to lose as the average customer cares more about his Big Mac than for the ketchup packet it comes with. McDonald's investors can thus rest easy.

For Heinz (and Berkshire Hathaway), the loss will obviously be bigger. The ending of such a long standing relationship with a huge customer like McDonald's will probably not be seen in the best light.

ConAgra investors, in the meanwhile, can keep an eye on any announcements from McDonald's, as they probably stand to gain the most.

McDonald's looks like it's ready to take over the world
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