CHEAP SEATS
Why U.S. shoppers just aren’t into Wal-Mart and McDonald’s anymore.
People are supposed to feel better about their finances and their futures when economies pick up after a recession and companies start hiring again. With a steady paycheque at the end of the week, cash in their pockets and months or even years of doing without now behind them, they’re supposed to start spending.
But people don’t always behave the way they’re supposed to. And there’s no better example of that right now than the American consumer and her frustratingly dogged refusal to realize how good she’s got it.
The recent performance of two of the most important consumer companies in the U.S. tells the story writ large.
Wal-Mart Stores Inc. reported quarterly earnings this week and disappointed analysts with shrinking profits and a same-store sales increase of only 1.1 per cent. Last month, McDonald’s Corp. disappointed too, reporting “negative guest traffic in all major segments” along with declining earnings per share and year-over-year revenue.
Not surprisingly, shares in both companies have been floundering lately, with McDonald’s providing negative returns this year, and Wal-Mart railing the S&P 500.
What the heck is going on? Certainly, both companies face challenges that are unique to them. Their earnings took a hit from their extensive international presences, but only in part because of the strong U.S. dollar. Wal-Mart has a price war on its hands with European retailers in the U.K., for instance; McDonald’s, meanwhile, is struggling operationally overseas, particularly in Japan.
But it’s in the U.S. where these two behemoths face their biggest challenges. And it’s all the more frustrating because it’s not supposed to be this way
On the face of it, consumers should be spending. The drop in gasoline prices over winter and spring is like a tax cut. Low interest rates mean credit is cheap. And U.S. companies are hiring, as the economy added more than 200,000 jobs last month.
But scratch the surface and things might not look so rosy.
While jobs are being created, wage growth is still basically flat. Consumer confidence has recently been on the decline. And Wal-Mart and McDonald’s aren’t the only victims of this absent consumer enthusiasm. Retail sales growth stalled in April, even though many analysts expected a strong uptick with the end of a tough winter.
Instead, Americans seem to be taking whatever extra cash they have and putting it in the bank (the savings rate continues to grow). Sitting here in the insulated north, we forget at our peril how hard hit American households were by the real estate crash and subsequent recession. Once bitten, twice shy. But it’s not altogether a simple case of a new miserliness.
When Americans are spending, it’s going into their homes — which kind of makes sense if you’ve been putting off investing in your house for years as the real estate market recovered.
They are also going out a lot: the U.S. National Restaurant Association last week announced that last month for the first time in history, Americans spent more on restaurant meals than on groceries.
None of this is good news for Wal-Mart, or for McDonald’s, though it’s something of a riddle why American restaurantgoers aren’t flocking to the Golden Arches.
Maybe the answer for both companies lies in brand fatigue, not to mention aging infrastructure. Some WalMart and McDonald’s outlets are looking pretty long in the tooth. But what they also have in common is that they are priced at the low end of the curve. And in the world of consumerism, cheap just ain’t what it used to be.
Gone are the days when a mass discounter such as WalMart always had the lowest prices for acceptable quality. These days, big-box retailers offer the same stuff or thereabouts for less. And if you’re middle class and want cheap clothing, you can find as much of it, at higher perceived value, at your local Gap or Banana Republic, where the sale racks are always full.
For Wal-Mart, that leaves the bulk of its value proposition in grocery, which now comprises more than half of the company’s revenue. That’s a really competitive market, and one where you wouldn’t necessar-
Cheap just ain’t what it used to be
ily expect more cash in pockets translating into higher sales. In the developed world, at least, people don’t buy more food just because they have more money.
McDonald’s, in contrast, is considered a consumer discretionary stock, but its position on the low end of the restaurant food chain doesn’t do it any favours when folks have more money to spend. In the U.S., the poor are still poor, and the middle class is moving on to other choices that they perceive as higher quality or healthier.
Really, if you just got a new job and had some cash burning a hole in your pocket, would you want to celebrate over a Filet-O-Fish and fries?
Still, neither McDonald’s nor Wal-Mart is going to disappear anytime soon. They are giant companies, run by smart people. For investors, these kinds of companies can be yield machines, reliably spinning out cash over many years.
But if either company wants to be more than that, it will need to figure out a way to address not just its short-term operational challenges, but also the structural shifts in the ways consumers spend.
Wal-Mart drove the midmarket out of retailing, and McDonald’s did much the same thing in restaurants. Maybe they are just victims of their own success, and have to figure out a way to either undercut the competition again, or claw their way up the value chain. Either way, it’s not likely to be easy.