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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 $3.42 and going forward we expect it to increase to $3.7 by end of 2020. 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 an average) to more and more restaurants. Should the ASC increase to $4.5 by the end of 2020, we could see a 15% 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 fails to rise from the current levels.
McDonald's owns and franchises its restaurants all over the world. By the end of 2013, the company had 35,429 restaurants in 120 countries, of which 28,691 were operated by franchisees and 6,738 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 and has nearly 90% of the market share.
In the overall fast food industry, McDonald's is the market leader followed by Subway and Yum! Brands.
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 & 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 the value of 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 6,738 restaurants self operated by McDonald's, 28,691 restaurants were operated by franchisees globally. Going forward, we expect the company operated stores to decline further 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 between McDonald's and Starbucks to intensify in the breakfast segment
Breakfast market is proving to be a profitable segment specially 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 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.
McDonald's faces operational problems in Russia and China
In August, 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, the company's meat supplier company in
China was accused of using contaminated meat products. Soon after the issue came to light, 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.
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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