Tag Archives: McDonalds

McDONALD’S INCREASES FEES – INSTRUCTIVE RELATIVE TO INEQUITY IN TODAY’S FRANCHISING STRUCTURE

McDONALD’S INCREASES FEES, INSTRUCTIVE RELATIVE TO INEQUITY IN TODAY’S FRANCHISING STRUCTURE

The world’s greatest restaurant franchising company, McDonald’s, announced a modification of their partnership structure with franchisees.  As of January 1st, they are ending a $300/month/store subsidy related to Happy Meals. They will also require franchisees to  jointly fund the tuition program, instead of corporate paying 100% (the amount of extra expense has not been disclosed). Lastly, for the moment, they are requiring operators to “pay as you go” for technology investment, resulting in a “temporary” expense of $423/per month per store starting in March. Franchisees are expressing their displeasure.

It should be noted that the franchise Agreement  calls for a 4% royalty, a 4% minimum advertising requirement, and over twenty small fees (from $74/yr./store to $1,100 per year/store) which amount to about $10,000/store/yr. Many franchisees also pay McDonald’s rent, which has been described as a “minimum vs 8.5% of sales”. The initial franchise fee is $45,000 and franchisees must be prepared to invest about 40% of the total cost of the restaurant, and that total investment ranges from $1.008M to $2.214M, according to the Franchise Disclosure Documents. The bottom line is that the average franchisee nets about $150k per year, which would be about 9-10% return on the average investment. It is unclear whether that return is in addition to the operator’s salary. In either case, franchisees, while not generating a huge return on the dollars invested,  are making a living, and earning it.

You can see why $723/month, as described above, about $9,000/store/year is a noticeable hit on an average profit of $150,000. All of this is in the context of the unprecedented challenges that the QSR industry has had to cope with. While McDonald’s has adjusted to the pandemic-related problems better than most, it is unclear whether profit/store is higher or lower than a year ago.

The above structure is typical within the restaurant franchising industry: An initial franchise fee (in the tens of thousands of dollars) plus an ongoing royalty of 4-5% of sales, plus advertising contributions of 2-4% plus a variety of small (but material in total) additional fees.

Ray Kroc started selling McDonald’s franchises in the 1950s. The upfront fee was $750 and the ongoing royalty was 1.9% of sales. By 1963 there were 460 stores in 42 states, the upfront fee had been increased to $12,000 and the royalty was 2.2%. In some cases, McDonald’s would build the store and rent to the franchisee. Even adjusting for inflation, the restaurant franchising industry has come a long, long way in the last sixty years.

We wrote, on March 11, 2019, the following article, which applies even more so today:

THE FRANCHISOR/FRANCHISEE ECONOMIC RELATIONSHIP – IT’S A NEW WORLD !!

Almost everybody has noticed that there is an increasing strain between franchisees and their franchisors.  It is no accident that new franchisee associations are being formed and existing organizations are getting more militant. There are many intangible reasons, as too many franchisors do not treat their “z’s” as partners. We have written many times that the “asset light”, “free cash flow” model is not reflecting the necessary investments in the system to keep franchisees as profitable as possible. Many franchisees are especially bothered by the fact that their franchisors are spending hundreds of millions, sometimes billions, of dollars buying back stock and making acquisitions, while leaving the franchised operators without the necessary new product development, technology upgrades, marketing initiatives, etc.etc.

With all of that in mind, the bottom line is the bottom line. Too many franchisees are suffering financially, under more pressure than ever. The typical franchise royalty is 5%, give or take a point, plus 2%, as an advertising contribution. There are often additional charges, not all that material in and of themselves, but adding to an already large burden. Let’s say the franchisee is fortunate enough to be making 17-18% store level EBITDA (and Depreciation is not free cash in the long run).  Rebating 7 points out of 17 or 18 points starts to feel like a pretty big load, and there is still local G&A to be carried. Even if store level EBITDA, before royalties, is in the low  twenties, 7 points gets to be a bother.  Additionally: many franchisees, Dunkin’ Donuts and Burger King and Jack in the Box are just a few examples of mature systems where decent money is still being made at the store level because the store leases were signed ten or fifteen years ago, so occupancy expenses are lower than today’s economics would allow. That’s, of course, why so few new units are being built by many mature franchised systems, especially in the USA. Today’s economics do not allow it.

When Ray Kroc started franchising McDonald’s restaurants over 60 years ago, the royalty was 1.9%. By the 1960s, franchisors had started charging 2-3%, by the 1970s 3-4%, by the eighties 4-5%, and 5% seems to be the standard today, plus advertising and other fees.

At the same time, there are no material expenses that are lower, as a percentage of sales, certainly not occupancy expenses or labor, and food costs are unpredictable commodities. The biggest single negative trend, that nobody would debate, is the immense competition that has become commonplace. Even in today’s over-stored situation, there are more new stores being built, within chains, than closing.  This competitive pressure has also created the need for far more support from the franchisor, if the increasingly critical public is to be satisfied and the franchisee partner is to succeed.  Over the last fifty years, as the franchisor should be providing more support and burdening the franchisee less, the trend has been just the reverse.

The answer: lower fees, especially ongoing royalties. 

This specific suggestion will not be adopted by existing large chains, because it would be such an obvious reduction of the current royalty stream. However, well established franchisors could, and should, absorb more of the additional systemwide needs, such as technology upgrades. “Mid-stage” franchising companies could put some part of the following suggestions in place.

If I were running an early stage franchising company, I would put in place a sliding scale royalty system, charging 2.5-3.0% at a modest sales level, higher if the franchisee does better. Give them a little room to make money if the store doesn’t do quite as well as everybody hopes. If the store clicks, everybody is happy and 4-5% on the higher sales won’t seem like such a burden. For my multi-unit franchisees,  I would charge lower up front fees for development of 2nd, 3rd and additional stores, and this is sometimes already being done (whether admitting it to Wall Street or not). This is logical and appropriate, because less franchisor support is required as a franchisee builds local infrastructure.

It seems likely that a young franchising company adopting this strategy would have a huge competitive edge and the total royalty stream is likely to build more rapidly using this progressive approach.  Profitable franchisees, and a more appropriate sharing of store level profits in today’s economic reality, make for a successful system in the long run.

Roger Lipton

McDONALD’S REPORTS Q3 – STOCK DOWN 7 POINTS – HOW BAD WAS IT?

McDONALD’S REPORTS Q3 – STOCK DOWN 7 POINTS – HOW BAD WAS IT?

McDonald’s reported third quarter this morning. Earnings per share virtually flat, up a penny to $2.10 per share. US comps up 4.8%, slightly less than the 5.2% expected. Global comp up 5.9%, slightly more than the 5.7% estimate. With 38,000 restaurants around the world, McDonald’s management has done a fine job over the last several years, keeping the brand relevant, improving product quality, service and the overall dining experience.

More important than the flat quarter, to our way of thinking, is the flat nine months. For both the quarter and the nine months of ’19 to date, operating income is down, pretax income is down, and after tax income is down. Earnings per share was virtually flat for the quarter and up a miniscule 1% for the nine months. This flat nine months performance was due to fewer shares outstanding, a result of the company buying back a cool twenty five billion dollars worth of stock over the last three years, which shrunk the average fully diluted shares outstanding by 11.3% from calendar ’16 to the nine months ending 9/30/19.

As a timely sevice to our readers, we are writing this in advance of the 11:00am conference call, which will no doubt talk about many operating initiatives. However:

Already disclosed is that, for company operated stores, on a 4.8% comp in the quarter, CGS was up 30 bp to 31.5%, Payroll and employee benefits was, admirably, down 70 bp to 28.1%, Occupancy & Other expenses was up 20 bp to 21.8%. Company operated store level margin was up 20 bp to 18.4%. For the nine months, the trends were similar, with store level margins up 10 bp to 17.5% on a 5.0% comp. This supports our long held contention that it is virtually impossible for a restaurant company to improve store level margins on a comp increase of only 2-3%, which is most typical of the best performing restaurant operators. McDonald’s, with scale and skill, showed only a 10-20bp margin increase on a 4.8-5.0% comp performance.

The nine months is in the rear view window, and it’s now a question of what the future holds. The company only provides specific guidance for the rest of ’19. All they have said is that: net restaurant additions will add about 1 percentage point to ’19 systemwide sales growth, each one point change in comps would change annual diluted earnings per share by about $0.06-.07 or less than 1% of the $8.02 total  estimated EPS for ’19, CGS is expected to increase 2-3% for all of ’19 (was up about 1% for nine months, so increasing), SG&A will increase 1-2% for the full year of ’19 including the recent acquisitions of Dynamic Yield and Apprente, interest expense will be up 13-15%, capex for all of ’19 will be about $2.3 billion ($1.5B in the US, two thirds related to 2,000 EOTF projects), about 1,200 new restaurants will open worldwide  and 400 will close.

OUR TAKE (without the benefit of the conference call)

McDonald’s management is doing a great job providing value to the customer, with improved products and service. On our last visit, we bought two quarter pounders with cheese (buy one, get the second for $1.00) plus a cup of coffee (for $1.00) for a total of $8.57 with NYS tax. We’ve got a value driven restaurant environment that is not getting any easier. McDonald’s has long dominated the QSR breakfast business, but Wendy’s and Burger King and Dunkin’ are getting increasingly aggressive in that area, and Starbucks doesn’t stop. We see no reason that McDonald’s operating results will improve materially in the near term. The $8.02 Bloomberg estimate of EPS for ’19 is versus $7.90 in ’18 and that is a result of fewer shares outstanding. The estimate as of the moment is for $8.73 per share (up 8.8%) but we doubt it. The dividend has just been raised to $1.25 per quarter (up from $1.16) which amounts to a 2.5% annual yield, but that can go away in one morning like today. . MCD is trading at 25.4x ’19 EPS estimates and 16.7x trailing EBITDA. Seems pretty fully valued to us.

Roger Lipton

McDONALD’S REPORTS Q4 – A 5.6% U.S.COMP – EPS UP 16% – GREAT, RIGHT? HOLD THE CHAMPAGNE!

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INCLUDED IN YOUR ANNUAL SUBSCRIPTION:

  • Broad economic insight. As described in “Restaurants/Retail – Why Bother?” the restaurant and retail industries provide a leading indicator of far broader economic trends. You no longer have to be the last to know.
  • Two to three analytical pieces per week (“Roger’s Rap”) personally written by Roger Lipton describing corporate developments within his industry specialization, including their relevance to the broader economy.
  • Periodic “macro” discussions personally written by Roger Lipton, analyzing fiscal and monetary matters that will likely affect your investments and your business.
  • Opportunity to “Ask Rog” about your personal concerns, regarding individual companies or broader economic trends. Roger will use his best efforts to answer questions submitted, obviously limited by the number of requests . He may answer your question by email directly and/or include your question with his “Roger’s Rap” releases.
  • You are provided access to “Friends of Rog”, depending on your financial and operational needs. The outstanding individuals suggested here, have been personally “vetted” by Roger over decades. Roger receives no compensation based on whether or not use their services.
  • A free copy of the legendary best selling book, How you can Profit from the coming devaluation, as shown at right, written in 1970 by Harry Browne, which predicted the 2000% rise in the price of gold. This profound piece is more relevant today than ever, so Roger re-published it in 2012. This book will help you preserve the fortune you are in the process of accumulating.

McDONALD’S (MCD) (OPPORTUNITY LOST), by Steve Pettise, “Friend of Rog”

To access this content, you must purchase Website Subscription.

INCLUDED IN YOUR ANNUAL SUBSCRIPTION:

  • Broad economic insight. As described in “Restaurants/Retail – Why Bother?” the restaurant and retail industries provide a leading indicator of far broader economic trends. You no longer have to be the last to know.
  • Two to three analytical pieces per week (“Roger’s Rap”) personally written by Roger Lipton describing corporate developments within his industry specialization, including their relevance to the broader economy.
  • Periodic “macro” discussions personally written by Roger Lipton, analyzing fiscal and monetary matters that will likely affect your investments and your business.
  • Opportunity to “Ask Rog” about your personal concerns, regarding individual companies or broader economic trends. Roger will use his best efforts to answer questions submitted, obviously limited by the number of requests . He may answer your question by email directly and/or include your question with his “Roger’s Rap” releases.
  • You are provided access to “Friends of Rog”, depending on your financial and operational needs. The outstanding individuals suggested here, have been personally “vetted” by Roger over decades. Roger receives no compensation based on whether or not use their services.
  • A free copy of the legendary best selling book, How you can Profit from the coming devaluation, as shown at right, written in 1970 by Harry Browne, which predicted the 2000% rise in the price of gold. This profound piece is more relevant today than ever, so Roger re-published it in 2012. This book will help you preserve the fortune you are in the process of accumulating.

McDONALD’S STOCK UP BIG! IS IT TOO LATE TO BUY?

To access this content, you must purchase Website Subscription.

INCLUDED IN YOUR ANNUAL SUBSCRIPTION:

  • Broad economic insight. As described in “Restaurants/Retail – Why Bother?” the restaurant and retail industries provide a leading indicator of far broader economic trends. You no longer have to be the last to know.
  • Two to three analytical pieces per week (“Roger’s Rap”) personally written by Roger Lipton describing corporate developments within his industry specialization, including their relevance to the broader economy.
  • Periodic “macro” discussions personally written by Roger Lipton, analyzing fiscal and monetary matters that will likely affect your investments and your business.
  • Opportunity to “Ask Rog” about your personal concerns, regarding individual companies or broader economic trends. Roger will use his best efforts to answer questions submitted, obviously limited by the number of requests . He may answer your question by email directly and/or include your question with his “Roger’s Rap” releases.
  • You are provided access to “Friends of Rog”, depending on your financial and operational needs. The outstanding individuals suggested here, have been personally “vetted” by Roger over decades. Roger receives no compensation based on whether or not use their services.
  • A free copy of the legendary best selling book, How you can Profit from the coming devaluation, as shown at right, written in 1970 by Harry Browne, which predicted the 2000% rise in the price of gold. This profound piece is more relevant today than ever, so Roger re-published it in 2012. This book will help you preserve the fortune you are in the process of accumulating.

ALL DAY BREAKFAST IS COMING! McDONALD’S NEEDS HELP!

ALL DAY BREAKFAST IS COMING! McDONALD’S NEEDS HELP!

Lots of chatter among investors relative to McDonald’s serving breakfast all day. In our opinion, this is far from a game changer. Not going to affect other breakfast purveyors, such as IHOP and Denny’s in casual dining, or Dunkin’ and Starbucks in quick service, in fact many others are piggybacking on MCD advertising to increase renewed emphasis on their own breakfast offerings. McDonald’s corporate still in relative disarray, with lots of franchisees looking for more consistent direction from above. Marketing message has been muddled for some time now, and industry trends have been unforgiving for operators functioning on less than all cylinders. McDonald’s stock doing better lately, but best thing going for MCD stock is the possibility of financial engineering of some sort relative to their huge real estate holdings.

YOU DON’T HAVE TO REINVENT THE WHEEL. VISIT THE GRAVEYARD, DON’T END UP THERE! – available to non-subscribers

I have followed the restaurant industry for four decades; have invested hundreds of times in chain restaurant companies (public and private). Have lost more times than I normally like to admit, and fortunately have earned a lot more than I have lost. I consider it “therapeutic” to review some of the previously public companies that have disappeared. I have studied them all, invested in and/or advised some of them, and interfaced with virtually all of the management teams. Industry legends such as Norman Brinker (Brinker Int’l), Dave Thomas (Wendy’s), Jim Patterson (Long John Silver’s), Harold Butler (Denny’s), Jim Collins (Sizzler), Allan Karp (Karp & Reilly), and many others were keynote speakers at my annual Restaurant Industry Conference during the eighties and nineties.
Among the companies that appeared (in no particular order) were: Max & Erma’s, Po Folks, Rax Restaurants, Shoney’s, Sizzler, Skolniks, Uno Restaurant , Magic Restaurants, GD Ritzy’s, D’Lites, Checkers, Daka International (Fuddruckers, Champps), GB Foods (Green Burrito), TPI Restaurants, Vicorp , Ground Round, Morgan’s Foods, Bayport Restaurant (Crabhouse), Blimpie, Boston Chicken, Main Street and Main (TGIF), Wall Street Deli, American Family Restaurants, Austin’s Steaks & Saloon, Boston Restaurant Associates (Pizzeria Regina), Italian Oven, New World Coffee, Pudgie’s Chicken, Rattlesnake Holding, Shells Seafood Restaurants, Rally’s, Buffets, Ciao Cucina, Logan’s Roadhouse, Rainforest Café. Most of these companies are GONE, None are publicly held any longer.
There are many others that didn’t necessarily appear at my conference. Remember Chi Chi’s and Ryan’s Family Steakhouse, two of the most attractive concepts from the early eighties. Both had fully loaded sales/investment ratios over 2:1 at the time.
Today there are established companies such as McDonald’s, Wendy’s, Jack In The Box, Yum Brands, Chipotle, Panera and others, as well as a new crop of publicly held companies such as Papa Murphy’s, Noodle’s, Potbelly, Habit Restaurants, Wing Stop, Rave (Pizza Inn and Pie Five), Zoe’s, One Hospitality (STK), Ignite (Joe’s Crab Shack and Brick House Tavern), Del Frisco’s, Fiesta (Pollo Tropical and Taco Cabana, Del Taco and others. The obvious message for restaurant managers, investors, lenders, analysts and investment bankers: There are lessons to be learned; hopefully I’ve learned a few, how about you?