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McDonald's - a strong year for franchising

Emilie Stevens, Equity Analyst | 29 January 2020 | A A A
McDonald's - a strong year for franchising

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McDonalds Corporation Com Stock US0.01

Sell: 221.34 | Buy: 221.42 | Change 2.75 (1.26%)
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Global comparable sales grew 5.9% over the year, the highest rate of growth McDonald's has seen in a decade, driven by strong growth internationally. Total revenue rose 3% over the year to $21.1bn.

Operating profit rose 6% to $9.1bn, attributed to strong sales growth among franchisees, in both the US and international businesses.

A fourth quarter dividend of $1.25 per share has been declared, compared to $1.16 last year. The group completed $5bn of buybacks during the year.

The shares rose 2.7% following the announcement.

View the latest McDonald's share price and how to deal

Our View

There's more to McDonald's than meets the eye.

That's because in many ways it acts more like a property company than a restaurant group. Around 75% of the restaurants are owned rather than leased, and over 90% are operated by franchise partners - albeit buying their supplies from McDonald's plc.

Shifting more business to a franchised model has seen revenue fall from a peak of $28.1bn in 2013 to $21bn this year. However, that's only half the story. With the responsibility for maintaining and running the restaurants shifted on to its partners, operating margins have risen from 31.2% to 43%. The net effect is positive for profits.

Franchise agreements are struck on 20 year timeframes, so the model has given McDonald's an improved quality of earnings too. As a result we think the net debt position, which has swelled to around 3 times annual cash earnings following substantial share buybacks, is manageable.

With much of the day-to-day out of the way, McDonald's can focus on overarching issues across the group. That's probably for the best, as the group had been ceding ground to close competitors in its core US market.

A recent sudden exit of CEO Steve Easterbrook, means Chris Kempczinski is now in charge. However, Easterbrook did a good job of getting the customers back - focusing on upgrading the menu, increasing the digital capability and working with partners to improve the in-store experience. The latest results suggest the strategy is working.

Across the globe around half of stores have been kitted out so far, with all the US stores due to have had their makeover by the end of 2020. That should provide low hanging fruit in the search for growth, which helps explain why the shares change hands for 24.6 times expected earnings, a sizeable premium to the longer-term average of 18.8.

That lofty rating puts pressure on the group to deliver, and investors shouldn't take anything for granted. Competition across the casual dining industry is intense, and politicians the world over are increasingly focused on diet and lifestyle choices.

Overall though, we think there are reasons for optimism. McDonald's has built an incredibly strong brand over the last 65 years, and the recent changes all seem to be with the long-term health of the business in mind. The prospective yield is 2.4%, and analysts are forecasting growth in the future, although there are no guarantees.

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Full Year Results (Results in constant currency)

Systemwide sales - which includes sales by franchisees - grew 7% in the year, surpassing $100bn for the first time.

In the US, comparable sales rose 5.0%, despite comparable transactions falling 1.9% over the year. This reflects strong sales of core products driven by marketing activity and menu price increases. Operating profits rose 1% to $4.1bn.

International Operated Markets saw comparable sales rise 6.1% over the year, with transactions growing 3.5%. Results were positive in all markets but growth was primarily driven by the U.K. and France. Operating profits rose 8% to $4.8bn.

Comparable sales in the International Developmental Licenced market (where the McDonald's brand is licenced to third parties) rose 7.2%. All geographies saw positive sales growth and transactions rose 2.2%. Operating profits rose 59% to $212m.

Cash generated from operating activities was 16.6% higher at $8.1bn, which together with a 12.7% decline in capital expenditure, resulted in free cash flow for the year of $5.7bn.

Despite this increase, net debt, measured as long term debts minus cash and cash equivalents, rose from $30.2bn to $33.2bn.

The company returned a total of $8.6bn to shareholders over the year, through a combination of dividends and buybacks, which saw it reach its target of returning $25bn to shareholders over the three-year period ending 2019.

Looking ahead to next year, the company plans to add around 1,000 net restaurants, which are expected to boost Systemwide sales by 1.5%. McDonald's expects its full year operating costs to rise by about 5 - 7%.

Find out more about McDonald's shares including how to invest

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.