Brinker International, Inc. (EAT)
Good Times Restaurants (GTIM)
UPDATED CORPORATE DESCRIPTIONS: McDONALD’S, YUM CHINA, TEXAS ROADHOUSE, WINGSTOP, BJ’S RESTAURANTS
YUM CHINA (YUMC)
TEXAS ROADHOUSE (TXRH)
BJ’S RESTAURANTS (BJRI)
UPDATED CORPORATE DESCRIPTIONS: CHIPOTLE (CMG), CHEESECAKE FACTORY (CAKE), McDONALD’S (MCD), DOMINO’S (DPZ) – with transcripts
FIVE UPDATED WRITEUPS, – KURA SUSHI (KRUS), ROCKY MOUNTAIN CHOCOLATE FACTORY (RMCF), McDONALD’S (MCD), STARBUCKS (SBUX) AND BRINKER ((EAT)
The links below take you to the updated corporate descriptions, which includes a link to the transcript of the most recent conference call.
Kura Sushi (KURA)
Rocky Mountain Chocolate Factory (RMCF)
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 !!
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.
WITH EARNINGS EXPECTED TOMORROW, OUR LATEST RESEARCH WRITEUP ON McDONALD’S (MCD) HAS BEEN SELECTED FOR RE-PUBLICATION AT SEEKING ALPHA, LINK BELOW: