COMPANY OVERVIEW (2017 10-K):
The Company operates and franchises McDonald’s restaurants, which serve a locally-relevant menu of quality food and beverages sold at various price points in more than 100 countries. McDonald’s global system is comprised of both Company-owned and franchised restaurants. McDonald’s franchised restaurants are owned and operated under one of the following structures – conventional franchise, developmental license or affiliate.
The Company is primarily a franchisor, with more than 90% of McDonald’s restaurants currently owned and operated by independent franchisees.
Of the 37,241 restaurants in 120 countries at year-end 2017, 34,108 were franchised (reflects 21,366 franchised to conventional franchisees, 6,945 licensed to developmental licensees and 5,797 licensed to foreign affiliates (“affiliates” – primarily in Japan and China) and 3,133 were operated by the Company.
SOURCES OF REVENUE (2017 10-K):
McDonald’s is the largest restaurant chain by revenue with $22,820 billion through the end of 2017. 56% of this revenue is derived from company units and 44% of the total revenue is from royalties and rental revenues from franchisees.
UNIT LEVEL ECONOMICS:
As of the end of 2017, AUV of traditional domestic stores opened at least 12 months were $2,947,600 for Company stores and $2,735,000 for franchise locations. Traditionally AUV has been higher at Company stores than at franchise locations. This gap decreased in 2017 due in large part to McDonald’s refranchising initiatives.
Below the top line, the unit level performance of franchised units is difficult to compare with Company units; mainly because the majority of franchised locations are leased, land and building, from the parent company. The Company recovers its investment with a minimum rent and percentage rent component.
Based on McDonald’s 2016 Franchise Disclosure Document (the most current FDD) it is estimated that the average franchise investment is $1.2M which on average generates EBITDA of 14.3% of sales and cash on cash return of 30.9% on the average franchise AUV of $2,624,000. The margins are net of royalty and fees of 4.2% and estimated average rent of 10.4%.
COMPANY STRATEGY (Source: March 2017 Investor Day Presentation):
Prior to the March 2017 Investor Day Presentation, Steve Easterbrook, President and CEO, had in 2015 outlined his turnaround strategy for the Company. The plan included grouping global operations into four segments: U.S., International lead market, International high growth markets, and foundation/corporate markets. This plan combined markets with similar characteristics, challenges and opportunities rather than by geography. The plan of realignment would better focus energy in addressing common challenges and a smoother ability to adopt best practices. As of January 1, 2017, this plan was in place.
In addition, Easterbrook (as of 3/17) targeted the refranchising of 4,000 company units, the majority in the high growth and foundational markets. As of October 1, 2017, this target was achieved – nearly a year ahead of schedule.
On March 1, 2017 McDonald’s unveiled its long-term global growth plan with its financial target and outlined the initiatives to unlock meaningful growth and increase guest counts. The Velocity Growth Plan is vital for growing sales and shareholder value for the future. The accelerated execution of this customer centric strategy is built on the following three pillars, all focusing on building a better McDonald’s:
- Retaining existing customers
- Regaining lost customers
- Converting casual to committed customers.
In each pillar, McDonald’s has established sustainable platforms that enable execution of the plan with greater speed, efficiency and impact while remaining relentlessly focused on the fundamentals of running great restaurants. Additionally, through three identified growth accelerators – Experience of the Future (“EOTF”), Digital, and Delivery – McDonald’s is enhancing the overall customer experience with hospitable, friendly service and ever-improving convenience for customers on their terms. The Company met aggressive deployment targets for each one of these accelerators in 2017. A further breakdown of these growth accelerators is listed below.
- Experience of the Future – McDonald’s currently has EOTF deployed in about one-third of the restaurants globally, with half of the U.S. restaurants expected to be deployed by the end of 2018.
Accelerating deployment of EOTF restaurants in the U.S. McDonald’s redirected a portion of capital saved from refranchising to modernize about 650 restaurants in 2017. This will give the U.S. approximately 2,500 Experience of the Future restaurants by year’s end. McDonald’s intends to have most of the traditional free-standing restaurants modernized by 2020.
- Digital – As the Company accelerated its pace of converting restaurants to EOTF, it is placing renewed emphasis on improving its existing service model. By evolving the technology platform, the Company is expanding choices for how customers order, pay and are served through additional functionality on its global mobile app, self-order kiosks and technology-driven models that enable table service and curb-side pick-up. In the U.S. alone, McDonald’s now has over 20 million registered users of the McDonald’s application.
Enhancing digital capabilities and the use of technology has dramatically elevated the customer experience. To enhance digital capabilities to elevate the customer experience, McDonald’s must be relevant to customers. This is being done through Kiosks, additional staffing to assist in the Kiosk process. Additionally, to skip the Drive-Thru, McDonald’s has introduced an improved order and pay app and chose curbside delivery while stopping the Drive-Thru.
- Delivery – The Company continues to further scale its delivery platform as a way of expanding the convenience customers receive from McDonald’s. In 2017, McDonald’s added delivery to 7,000 restaurants in 21 different countries. Including previously offering of delivery in Asia and the Middle East, McDonald’s is now delivering meals from over 10,000 restaurants. In addition to added convenience, delivery transactions tend to realize a higher average check and a higher customer satisfaction rating.
Redefining customer convenience through delivery. McDonald’s is uniquely positioned to be a world leader in delivery. 75% of the population in the USA, France, Canada, UK and Germany live within 3 miles of a McDonald’s and in 2017 McDonald’s had annual sales in delivery of over $1B across various markets – mainly in Asia, China, Singapore and South Korea.
RETURNS TO SHAREHOLDERS:
In 2017 the Company returned $7.7 billion to shareholders through share repurchases and dividends and recently announced a new $22-24B cash return target for the 3-year period ending 2019. The dividend provides a yield of 2.5% at the current stock price. The common stock, after trading in a relatively narrow range from $90 to $100 per share from early 2012 through Q3’15, has been one of the better performers among restaurant companies since then, rising about 60%.
RECENT DEVELOPMENTS (Per Q4’17 Earnings Release and Conf.Call on 1/30/18):
McDonald’s continued to outperform most of its QSR peers in Q4’17, with global comp sales up 5.5% (4.5% in the US), including positive guest counts up 1.5% in Q4 and 1.9% for year. While consolidated revenues were down 15% in constant currencies (CC), due to refranchising, systemwide sales were up 8% CC and consolidated operated income was up 6% CC (4% in the US). Excluding the Tax Act adjustment, diluted EPS was up 16% CC, reflecting the impact of share repurchase, $661M worth in Q4 alone, and a cool $4.6B for the year. Also in Q4, the dividend was increased 7% to $1.01 quarterly. With the exception of South Korea, virtually all segments were strong. Development plans call for the opening of about 1,000 new restaurants in ’18 (75% non-US), with the investment of about $2.4B of capital, the majority of which will be accelerated deployment of the EOF in the US.
In the US, in Q4, company operated margins declined 150 bp, due to higher labor costs and higher commodity costs. Menu pricing was up 3%, which is expected to adjust downward in Q4’18 with the $1,$2,$3 Dollar Menu. Delivery is now offered in over 10,000 locations worldwide, and these orders have an average check 1.5-2.0x other orders. There are now over 20M registered users of the mobile app, now offered in 20,000 worldwide locations.
The refranchising effort continues and reported results could be “choppy” with the consolidated transaction effect. The effective tax rate will be 25-27%, down from the historical range of 31-33%, allowing for a cash savings of $400-500M which will be available for other uses. The priorities remain the same, first to invest in the business, second to pay dividends, and, lastly, for the repurchase of stock.
Regarding the planned reduction of G&A, $300M of the targeted $500M was achieved in ’17, the rest to be achieved through 2019. Capital expenditures will be about $2.4B in ’18, $1.5B of which will be dedicated to the US, primarily focused on acceleration of EOF.
As of the end of January, with the conference call, the new $1,$2,$3 menu was only in place for 20 days, so no comment was provided relative to the customer reaction other than “we are not seeing a material shift in product mix”. Subsequently, Wall Street speculation was that the response was not especially good, which caused a short term correction in the stock (since reversed), but our channel checks have indicated continuing positive comp sales in Q1, in spite of the possibly tepid response to this particular offering. The $1 “any size” drink, as well as the $3 Happy Meal and continuation of previously successful offerings such as All Day Breakfast are no doubt contributing to ongoing strength.
Relative to expected operating margins, management indicated that historically a 2-3% comp was necessary, but something higher is necessary today because of labor pressures. Since comps have exceeded that recently, and are expected to continue, franchisee cash flow in the US was said to be “near all-time high” and operators are willing to move forward with EOTF projects.
Delivery continues to be a major initiative, one of 5-7 major platforms for growth, with around 5,000 US locations utilizing UberEATs. Further expansion through UberEATs naturally depends on their geographical coverage, and the expansion rate may slow because major urban centers are already covered. Markets such as UK, Australia, Canada and the Netherlands are apparently getting superior results from delivery and the Company is studying those markets to adopt best practices. Margins are lower due to the delivery fees, but the business seems to be largely incremental, so the profit contribution is worthwhile even if the overall margin rate comes down.
The fresh beef initiative provides high hope for a positive customer reaction, which has apparently been the case so far. As of the Conference Call, 2-3,000 restaurants had the fresh beef for Quarter Pounder and Signature platforms. Further rollout, involving new distribution procedures and store level training continues. The rollout of this major new program continues.
Overall, the multiple initiatives of this premier worldwide brand continue to be the focus. There is no reason to believe that the momentum established by Steve Easterbrook and his team will be short circuited. The operating improvements complemented by unmatched marketing muscle should allow McDonald’s to provide the latest chapter as they once again “write the book” in the QSR business.