Most investors know that McDonald's (MCD 0.38%) has had a bad year. Sales in the United States and across the world are falling, due to a variety of headwinds. One culprit is changing consumer tastes in developed countries, and now a food-quality scare has caused sales in China to suffer tremendously.
Nevertheless, McDonald's plans to spend a lot of money to open new restaurants. Management has ambitious plans for capital expenditures this year, which it hopes will help the company overcome its disturbing decline in sales this year.
While it might seem foolish to spend so aggressively in such a difficult business climate, McDonald's is doing what is necessary to secure future growth.
Will shareholders be lovin' McDonald's capital expenditure plans?
Late last year, McDonald's management unveiled a "Plan to Win" strategy to restore growth. This included stabilizing mature markets like the United States and Europe, but the most ambitious part of the plan was to spend aggressively across the world. McDonald's said it would spend as much as $3 billion in 2014 on capital projects. This represents a roughly 6% increase from the prior year, and most of the capital expenditures would be allocated to new restaurant openings in emerging markets such as China, India, and Africa. In all, capital expenditures would be used for 1,500-1,600 new restaurant openings and 1,000 reimagings.
McDonald's capital expenditures reached $1.1 billion over the first half of the year with lackluster performance. McDonald's put up flat earnings and just 2% total sales growth over the first half of the year.
Since the second quarter ended, the situation has become even worse for the burger giant. A recent public relations nightmare regarding the safety of food in China caused sales there to fall off a cliff. Global comparable sales, which measures sales at restaurants open at least one year, fell 2.5% in July and 3.7% in August. This was primarily due to the emerging market segment: comparable sales in the Asia-Pacific, Middle East, and Africa fell 7.3% in July and 14.5% in August.
Aggressive capital expenditures are still a wise strategy
In this context, opening so many new restaurants in regions of the world where sales are collapsing seems akin to flushing shareholders' money down a toilet. The mature United States and Europe markets have flatlined. Consumers are increasingly opting for healthier, fresher foods and moving away from fast food. The emerging markets are the last remaining growth opportunity across the globe. While the results from China are downright ugly, it's reasonable to think this is a short-term issue.
Yum! Brands (YUM +1.38%) -- operator of chains including KFC and Taco Bell -- faced a similar problem last year, when a food-quality scare caused sales in China to decline significantly in the span of just a few quarters. However, Yum! slowly recovered, as consumers tend to forgive and forget these scandals over time. Yum! is back to growth. Management expects as much as 10% earnings-per-share growth this year.
Even though McDonald's comparable-restaurant sales are struggling, opening new restaurants is still a very profitable venture for McDonald's. That's because McDonald's carries very high margins for its restaurants that put it near the top of its industry. For example, McDonald's operating profit margin stood at approximately 30% as a percentage of revenue through the first six-months of the year. By contrast, Yum! Brands' operating profit margin is 20% over its first nine months of the fiscal year.
Foolish Thoughts
Yum!'s experience offers at least some precedent that fast-food companies can recover from these events. McDonald's has little choice but to proceed with its capital spending priorities in emerging nations, because that's where future growth will come from.
For these reasons, McDonald's shareholders should approve of the company's capital expenditure plans.
