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Investment Overview for McDonald's (NYSE:MCD)
Below are key drivers of McDonald's value that present opportunities for upside or downside to the current Trefis price estimate:
Franchisee Rent & Fees
- Average Spend per Customer Visit at McDonald's Franchised Restaurant: Historically, the Average Spend per Customer (ASC) has increased at a rate of 3-4% per year. In 2013, it was $3.34 and going forward we expect it to increase to $3.36 by end of 2021. However, McDonald's has been pushing hard to improve its brand image by refurbishing restaurants and introducing free Wi-Fi. The company is also extending its McCafe brand (which report higher revenues on average) to more and more restaurants. Should the figure increase to $4.00 by the end of 2021, we could see a 17% upside to the Trefis price estimates. At the same time, McDonald's is opening new outlets mostly in developing countries, which usually witness a lower ASC, primarily due to purchasing power disparity. There could be a 10% downside if the ASC drops to $3.00 by the end of our forecast period.
- Annual Customers per McDonald's Restaurant: Historically, the number of annual customers had been increasing till 2011, at a rate of 4-5%. However, in 2012, the figure witnessed a decline from 740,600 in 2011, to 730,400 in 2012. The trend continued in 2013, as the figure further declined to 721,000. The figure dropped 2.3% to 704,000 in 2014. The decline was primarily due to the tough competition from fast-casual restaurants, especially Chipotle Mexican Grill, as well as the shift in dining preferences due to health concerns related to fast food. Apart from stiff competition by the fast casual segment, the company witnessed a drop in customer traffic in Asian countries. Trefis estimates the annual customer count to increase at a rate of 0.5- 0.8% for the next 5-6 years. If the health concerns reduce the customers to McDonald's, and the annual customer count reaches just 709,000 by the end of our forecast period, we could see a 5% downside to the Trefis price estimate. At the same time, if the company manages to sustain or even improve the customer traffic by implementing strategies to introduce organic food items, and the figure reaches 800,000 by the end of our forecast period, we could see a 10% upside to the Trefis price estimate.
McDonald's owns and franchises its restaurants all over the world. As of March 31, 2015, the company had 36,290 restaurants in 119 countries, of which 29,556 were operated by franchisees and 6,734 were operated by the company.
McDonald’s essentially offers a uniform menu, though with minor variations to suit the local taste. A typical McDonald’s menu includes burgers, sandwiches, salads, snacks, breakfast sandwiches (McMuffins), beverages (soft drinks, coffee, milk shakes, juices), and desserts (ice cream, pies, smoothies).
McDonald's competes primarily with Wendy's and Burger King in the hamburger fast food category. However, in the overall fast food industry, McDonald's is the market leader with 22% market share followed by Yum! Brands and Subway.
We believe that Franchisee Rent & Fees is more valuable than Franchisee Royalties and Company Operated divisions due to the following reasons:
Rent & fees income is two times more than franchisee royalties income
Both the Franchisee Rent & Fees and Franchisee Royalties divisions represent the two different channels of revenue contribution from McDonald's franchised restaurants. McDonald's operates three kind of franchised restaurants (conventional, developmental, and affiliated) and charges them royalty, rental, and initial setup fees. While royalty is charged to all franchised restaurants, rental and initial set up fees are paid by only conventional franchises.
Rent & fees charged as a percentage of sales is approximately two times greater than the royalty percentage charged to franchisees. This makes the Franchisee Rent & Fees division nearly twice as valuable as the Franchisee Royalties division.
Franchises profit margin is 4x that of company operated restaurants
Company-operated restaurants are low margin businesses (~20% operating margin) as compared to franchised restaurants (~80% operating margin). The difference in margins is mainly because of the extra costs involved with company-operated restaurants, such as employees and operational costs, which are absent for franchised restaurants. This is the primary reason why McDonald's and other chains prefer the franchise model despite lower revenues.
Number of franchised stores is nearly four times the number of company operated restaurants
Compared to 6,734 restaurants self-operated by McDonald's, 29,556 restaurants were operated by franchisees globally. Going forward, we expect the company operated stores to increase very slightly as McDonald's re-franchises them.
McCafe gives McDonald's a strong presence in the specialty coffee segment
McCafe represents McDonald's foray into the high-margin caffeinated beverages market dominated by premium coffee chain Starbucks. McDonald's has been able to keep the prices competitive and margins healthy due to its excellent store network, its marketing muscle, and a highly efficient supply chain. McCafe's menu has been extended to more than coffee and now includes fruit smoothies, mocha, and chocolate shakes.
Competition among the top fast food chains to intensify in the breakfast segment
The breakfast market is proving to be a profitable segment especially in the U.S. McDonald's is the dominant player in the breakfast segment with a market share of over 30%. McDonald's ensures new items are added to the breakfast menu regularly. However, it now faces serious competition as a number of rivals such as Dunkin' Brands, Restaurant Brands International, Taco Bell, and Starbucks have stepped up their game in the breakfast segment. Starbucks is in the process of reinvigorating its breakfast menu with the help of baked goodies launched under the La Boulange brand. Restaurant Brands International houses two well renowned brands: Burger King and Tim Hortons, both of which are already a strong presence in the breakfast market. Dunkin' Donuts has also revamped its breakfast menu to cater to the needs of its customers.
McDonald's faces operational problems in Russia, Japan, and China
In August, 2014, Russia’s food safety watchdog ordered the temporary closure of five McDonald’s restaurants in Moscow and Southern Stavropol region, on claims of alleged sanitary violations. However, experts believe that the decision comes as a result of tense U.S. - Russian political ties over Ukraine. The temporary closures are already hurting the company’s sales, as four of the five outlets were in the central Moscow region, which generally receive a huge daily footfall. Moreover, the outlet on Pushkin Square is the chain’s most frequently visited franchise in the world, according to the company’s website.
Moreover, in July, 2014, the company's meat supplier company in China was accused of using contaminated meat products. Soon after the issue came to light, the Chinese government issued a ban on import and sales of products processed by that group. As a result of the ban, sales of McDonald’s popular chicken nuggets and chicken fillets were suspended in many Shanghai branches. This scandal also affected the company's Japan unit.
Company announces turnaround plan including worldwide business restructuring
On May 4, 2015, the company's new CEO Steve Easterbrook announced initial steps of McDonald's turnaround plan. It was mentioned that beginning July 1, the company will operate under a new organizational structure with four market segments: U.S., International lead markets, High-growth markets, and Foundational markets. Apart from this, new refranchising targets and financial updates were announced.
Trefis Forecast Rationale for Number of Company Operated Restaurants
Company Operated Restaurants are restaurants owned completely by McDonald's, and the company is responsible for all its activities. All sales recorded at these restaurants are reported as revenues for the company.
Before the great recession of 2008, company operated restaurants were on a declining trend due to company's shift to franchised restaurants. However, the last three years have seen company-operated restaurants rising mainly on account of Chinese expansion. In 2012, McDonald's had 6598 restaurants globally which were company-operated. This figure increased to 6,738 by the end of 2013. In 2014, the company closed net 24 company-operated restaurants, to take the total count to 6,714.
Most McDonald's restaurants in China are company-operated. Going forward, we expect the number of company-operated restaurants to increase to around 6,900 by the end of our forecast period.
Trefis considered the following factors for its forecast:
Back to Company Overview
- McDonald's will open up around 600-700 net new restaurants globally in 2015
- McDonald's is under-penetrated in some of the largest markets in the world and sees a huge growth potential in the long run.
- Some of the markets in which McDonald's plans to aggressively expand in the next few years are China, India, Russia, and Eastern Europe.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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