Cheap burgers, not shares - McDonald's Corp. to sell shares in Japan - Brief Article - Statistical Data Included

Business Asia, July, 2001

YOSHIO INAMURA STILL remembers when he was a 17-year-old standing in line at Japan's Ginza shopping district to try a hamburger for the first time.

Three decades on, the fund manager at Tokyo-Mitsubishi Asset Management says the thrill has gone. He has no appetite for McDonald's Japan Ltd -- its burgers or the shares it plans to sell starting 26 July.

"The company has already run up its growth," said Inamura. "McDonald's Japan is running a time-machine-like management by copying business practices which were successful in the US 20 to 30 years ago."

Inamura's concern, shared by other investors, is that profit growth has peaked as hamburgers have lost the novelty of 30 years ago, when the Japanese diet was mostly fish and rice. Rivals Yoshinoya D&C Co and Matsuya Foods Co now serve up beef, chicken, and even salmon with rice just as fast as McDonald's.

While McDonald's has responded by undercutting rivals on price, a weakening yen may increase costs and undermine that strategy. Its burgers may be cheaper, but its shares won't be. They will be sold at 31 times estimated earnings, higher than Yoshinoya's 21 times and its US parent's 19 times.

Investors say the company needs to expand into new food businesses similar to the US, where the parent company operates restaurant chains that serve pizza, chicken and Mexican food.

"If they stick with hamburgers for a long time, the company may not be able to cope with Japan's growing aged society," said Kazuyuki Katsushima, a retail analyst at UFJ Partners Asset Management Co.

People in their twenties visited McDonald's 15 times a year, while people above their forties, like Inamura, visited only twice, according to the company's latest survey.

The company and its shareholders will sell 26.2 million shares to raise as much as 92 billion yen, Japan's largest initial public offering this year, according to share sale documents.

The company will use share proceeds to open 400 more shops, buy land for outlets and may even start new food businesses, said president Den Fujita. While he didn't say what sort of business may be started, Fujita admitted: "Noodles are still my favourite food because that's what I ate when I was twelve years old."

To tempt investors, the shares will be sold at about 3500 yen ($54), 30 per cent lower than the original plan of 5000 yen, bankers involved in the sale said. To attract individuals frustrated with bank interest rates close to zero, the company will sell shares in 100 share lots costing 350,000 yen, instead of the traditional 1000-share lot.

Even that may not be enough, investors said.

The price of 31 times estimated earnings indicated in share sale documents compares with 14 times for rival Mos Burger. While McDonald's Japan boasts sales five times bigger and sells two out of every three hamburgers in Japan, its size also means rapid sales growth will be harder to come by.

The stock is more expensive than Fast Retailing Co, for example, even though the operator of discount casual clothing stores doubled sales last year.

The only saving grace for McDonald's may be Japan's high unemployment and stagnant wages, which are turning Japanese to 200 yen Big Macs instead of more expensive meals. The company sells hamburgers at 65 yen and cheeseburgers at 80 yen during weekdays, one-third the price Mos Burger charges and half the price at No 3 chain Lotteria Co. "McDonald's is one of a few winners in Japan's deflationary economy," said Naohiko Sasaki from Kokusai Asset Management Co.

The company kept prices low by importing more than 20 per cent of the food it uses at favourable exchange rates, using its parent's huge distribution network. A strong yen over the past two years made imports of potatoes and beef cheaper, helping it to become its parent's most profitable overseas unit.

Net income last year rose six per cent to a record 16.8 billion yen from a year earlier. Sales increased nine per cent to 357.9 billion yen.

For the next fiscal year, the weak yen is likely to increase the cost of imported materials. The company set a currency rate of 94 yen to the dollar for this fiscal year. The yen has dropped eight per cent this year.

The company expects pre-tax profit to decline eight per cent in 2001 because of a seven billion yen increase in royalty payments to its parent and rising investment costs. Pre-tax profit fell 6.7 per cent in the previous year.

"It is about time for them to try something different, but chances are they'll face more severe competition," said Tokyo-Mitsubishi Asset Management's Inamura.