Will Mad Cow Trample Mickey D's?

Justified or not, fears of the disease have already hurt the giant burger slinger, and the rest of the year could be rocky

By David Shook

Here's something you probably didn't know: Yes, McDonald's (MCD ) still gets most of its sales revenue from the U.S., but Europe and Asia account for the overwhelming majority of the company's growth. And surprisingly, even though McDonald's sells more fast food in the U.S. than in any other market, it gets only slightly more than a third of its operating income from domestic outlets, where most of its restaurants are franchised.

It now gets an equal third from sales in Europe, where McDonald's owns most of the restaurants and earns much more per location. The remaining third of sales come from the rest of the world. Small wonder that because of mad-cow near-hysteria in Europe, the world's most famous hamburger chain in January reported its first down quarter in 36 years as a public company.

Even though no more than a few head of cattle in Europe have been diagnosed with the disease, it's easy to see why fears have persisted. The bizarre brain disease can lead to a slow but certain death in humans, scientists say. And the panic about mad-cow' disease has yet to subside on the Continent. Now, the mere whisper of mad cow infiltrating the U.S. can send the hamburger king's stock reeling.


  Consider a report on Jan. 25 that a Texas feed mill may have violated safety procedures by feeding cattle the remains of other cattle (the practice that allowed the spread of mad cow in Britain). Although the company, Purina Mills (PMIL ), said the cows were quarantined, traders on Wall Street bolted. McDonald's stock fell about 7% before recovering later in the day. "Traders were selling McDonald's and spreading rumors of mad-cow reports in Texas -- even though the incident there was just a safety precaution," says J.P. Morgan analyst John Ivankoe.

The rapid drop gave investors a glimpse of how vulnerable McDonald's and other hamburger chains are. "The stock may have to mark time, given the near-term pressures from [mad-cow disease concerns] and currency and investor apprehension," says Merrill Lynch's Peter Oakes, referring to the weakened euro last year that compounded McDonald's woes in Europe. For investors, that's a red flag, especially for the near-term.

True, McDonald's shares remain damaged by the poor earnings results. The stock has fallen 16%, to $29.50 a share, since Jan. 17, when it briefly touched its one-year high of $35 before investors scaled back again. And while the problems linger across the Atlantic, sales are holding steady in the U.S., where Americans take great pride in having the highest quality beef in the world. The U.S. hasn't yet had a single case of mad cow in its meat supply, and there's no evidence that the beef supply is at risk.


  But given the decline in consumer confidence in Europe's beef supply, McDonald's is likely to have more downward pressure on its already battered stock price in 2001. "Perhaps we'll see a near-term sales blip," says Ann Gurkin of Davenport & Co. "But it's highly unlikely. Americans just aren't going to stop eating beef." The consensus earnings estimate is for flat earnings growth in the first quarter of 2001 and $1.62 a share for the year, up from $1.46 in 2000.

On Jan. 24, McDonald's, the world's largest buyer of beef, told investors that safety concerns in Europe had hurt fourth-quarter results. It was the first time in more than two years that the company missed analysts' earnings targets, too. Net earnings for the quarter were $452 million, down from $486 million a year earlier.

While global sales rose 2%, to nearly $10 billion, McDonald's experienced a 9% falloff in Europe -- where the company opened 517 restaurants last year. The company attributed the sluggish sales to unfavorable currency translation and declining consumer confidence in Europe over mad cow. It's possible that mad-cow fears could hamper the fast-food giant's sales even further in 2001.


  The Oak Brook (Ill.) company isn't commenting publicly on the mad-cow disease fears and declined repeated requests for comment for this story. But it's clear that McDonald's isn't ignoring the problem. It works hard polishing its image in the U.S. and abroad -- vigorously defending itself against what it perceives as unfair or false reports about its beef manufacturing with all the resources available to a company that has $40 billion in annual revenue.

However, such aggressiveness has backfired on occasion. Remember the Pyhrric courtroom victory over environmentalists in Britain who made libelous charges about McDonald's manufacturing practices? The company sued the two activists and after a 313-day trial, garnered a guilty verdict against them in 1997. But the case heaped criticism on the burgermaker and threw a spotlight on McDonald's beef- and egg-processing practices.

The U.S. has the best-managed food-handling and safety measures in the world, the most thorough testing procedures, and the quickest response to any warning on meat products. So says the beef industry -- the collective voice of cattlemen and beef producers who encourage people to eat as much cow as possible.

The companies that sell the most beef -- hamburger chains like McDonald's -- say they take thorough care to monitor quality and keep it as high as possible. "Most companies like Burger King and McDonald's have consistently good quality meat suppliers that must meet stringent standards," says a former McDonald's corporate manager who now works for Burger King.

McDonald's is counting on Americans' insatiable appetite for hamburgers to see this controversy through to its end. But with mad cow possibly still hampering Europeans' desire for a Double Cheeseburger, investors interested in McDonald's in the near term might be wiser keep beef off the menu.

Shook covers financial markets and biotechnology for BW Online in New York

Edited by Beth Belton

Before it's here, it's on the Bloomberg Terminal.