McDonald’s Corporation (NYSE:MCD), the world’s biggest fast food chain, has more than 33,000 restaurants worldwide. More than 80% of its global restaurants are franchised while the remaining 20% are company-operated. Its target audience is pretty much everyone who has a basic source of income in developed countries and the strata above the lower middle class in developing countries. It positions itself as a no frills restaurant chain offering good quality for value meals that customers can enjoy . McDonald’s had an operating income of $8.5 billion on $27 billion of revenues in 2011. 
(a) Company-Operated Restaurants: These restaurants are run by McDonald’s and accounted for more than $18 billion in revenues. Expenses related to commodities, occupancy and labor have to be borne by the company itself. Historically, EBITDA margins have been around 18%. Company-operated restaurants contributed about a third to its total profits.
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(b) Franchised Restaurants: McDonald’s generally rents/leases the land to its franchisees. It then collects rent as well as royalty (both as a % of franchisee sales) along with a one-time initial fees from its franchisees. Not all of the franchised restaurants may have the land owned by McDonald’s. In such cases, franchisees only pay royalty and initial fees. Such franchisees are called developmental licensees.
Franchising as a business has very high margins. For McDonald’s, adjusted EBITDA margins exceeded 80% in 2011.
Rent accounts for about two-thirds of the franchised profits whereas royalty constitutes about one-third.
In terms of revenues, the U.S. contributed about 32% to total revenues while Europe’s contribution was a little more than 40%. APEMA (Asia/Pacific, Middle East and Africa) accounted for about 22% of total revenues. However, it is important to note that due to the franchising nature of the business, only a fraction of the franchisee sales are added on to the company’s financials. Therefore, the more accurate way of judging a region’s importance is its percentage contribution to operating profits or total franchisee sales. Since the franchisee sales by region are not available for McDonald’s, we consider operating profit.
Due to a higher proportion of company-operated restaurants in Europe, the region’s revenue contribution is higher than its operating profit contribution. The U.S. leads the pack in terms of contribution to operating profits. It accounted for more than 40% of operating profits followed by Europe’s 36% in 2011.
Expansion and Localization
McDonald’s opened 773 net new restaurants in 2011 and will add another 900 in 2012. Its capital expenditure for 2012 is expected to be around $2.9 billion. Half of this will be used to open new restaurants while the remainder will be used to upgrade the existing restaurants to make them appear more upscale. We expect the company to add at least 750-800 restaurants annually for the next few years as there is still a significant opportunity left to expand in China, India, Russia, East Europe and Africa.
Internationally, McDonald’s adapts its menu to reflect the tastes and preferences of the local population. Some of McDonald’s menu items developed exclusively for the local population include Bubur Ayam McD (Malaysia), McAloo Tikki (India), McArabia (Egypt), McMollete (Mexico), McPollo (Chile), McKroket (The Netherlands), McTurco (Turkey), McLaks (Norway), Shaka Shaka Chicken (Singapore), Koroke Burger (Japan), and so on.
Due to its perceived image of a restaurant chain serving mass produced and unhealthy food, it is often criticized for promoting obesity. Therefore, it is trying to change its image by using more natural/healthy ingredients, displaying the calorie content, advertising commercials emphasizing on the freshness of raw materials and remodeling its restaurants to make them look upscale in order to attract more health-conscious consumers.
McDonald’s started the year strongly but its same-store sales have slowed down lately. It even turned negative for the first time in nine years. McDonald’s plans to offer more products as part of its dollar menu in order to attract footfalls in a weak consumer spending environment. Internationally, it is focusing on value meals such as the 100 yen menu in Japan and the 2 euro burger in France. This seems to have had some initial success with same-store sales up 2.4% in November.
However, it is too early to comment whether McDonald’s has successfully been able to turn the tide. A warm winter resulted in higher than expected sales for McDonald’s at the end of 2011 (and the start of 2012), so the growth figures in the next couple of quarters face tough comparisons. The extra emphasis on value meals could also put a downward pressure to its company-operated margins. ((McDonald’s ‘Dollar Menu’ sparks November sales rebound, December 11, 2012, chicagotribune.com))
We have a $93.60 price estimate for McDonald’s, which is about 5% higher than the current market price.Notes: