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McDonalds - COVID-19 having a significant impact

Emilie Stevens, Equity Analyst | 9 April 2020 | A A A
McDonalds - COVID-19 having a significant impact

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McDonalds Corporation Com Stock US0.01

Sell: 243.22 | Buy: 243.31 | Change -1.30 (-0.53%)
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Despite a good start to 2020, McDonald's said coronavirus is having a significant impact. Total comparable sales for the first quarter were down 3.4%, with growth in January and February, masking a 22.2% decline in March.

Around 75% of McDonalds restaurants across the world remain operational, with most adapting to focus on Drive-thru, Delivery, and/or Take-away.

The shares remained broadly flat in afterhours trading.

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Our View

A third of the world is in lockdown - that makes dining a very tricky industry to be in at the moment.

However, McDonald's isn't your average restaurant and this should provide it with a degree of shelter amid the current pandemic.

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.

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

While service is disrupted, knocking both the franchised restaurants' and McDonald's earnings (who receive a share of the cut) - McDonald's is not on the hook for restaurant running costs.

That said, if the pandemic and economic fallout are severe, this protection will only stretch so far. If large numbers of franchisees are forced out of business it wouldn't be the best news, but it's too soon to say what the outcome could be.

With earnings uncertain, it's important to look at the balance sheet.

The group has access to $3.5bn in undrawn credit and recently raised an additional $6.5bn of new finance. That's a substantial amount of cash to have access to, and adds a layer of protection. When we last heard from the group on 29 January, McDonald's net debt was around 3 times annual cash earnings. While that's higher than we'd like, it's not unmanageable. It's something to keep an eye though, as an extended hit to profits could see even the best balance sheets come under strain, as it becomes harder to service the interest payments on debt.

To preserve cash McDonald's is pausing the roll out of new openings and restaurant makeovers. That's not an existential problem, but is a shame because it's a key part of the group's competitive strategy, and McDonald's has been feeling the heat in the key US market.

In light of the challenges, McDonald's said it remained confident in its resilience but is not complacent. We think that's a fair assessment. However, until we've come out the other side, the dining industry will continue to take a hit. The longer the disruption the bigger the dent, so things could still get worse before they get better.

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Coronavirus update

In the first two months of 2020 comparable sales grew 8.1% in the US, 8.5% in International Operated Markets, driven by a rise in the number of customers and average bill value. In the International Developmental Licenced market (where the McDonald's brand is licenced to third parties) comparable sales rose 3.7%, impacted by restaurant closures in China.

However, in mid-march McDonald's experienced a significant decline in results, as governments and consumers responded to the pandemic. In March comparable sales in the US fell 13.4%, International Operated Markets dropped 34.7% and International Developmental Licenced sales fell 19.4%.

As at 8 April nearly all McDonald's restaurants in the US are operating through Drive-thru, Delivery, & Take-away only. It's a similar story overseas but with 45% remaining operational - largely reflecting European closures. 75% of international licensee restaurants are operational, China's nearly fully operational again but is seeing reduced demand. Japanese restaurants are open and 60% are in Brazil.

McDonald's has taken a number of steps to preserve cash which include suspending the share buyback programme and reducing capital expenditure by $1bn. Both the CEO and Executive Directors have volunteered cuts to their base salary.

In most markets McDonald's has deferred the cash collection for certain rent and royalties franchisees earn, but it will continue to recognise the revenue as sales happen.

In light of the disruption, McDonald's expects to recognise around $75m additional costs in the first quarter.

The group secured $6.5bn of new financing in the quarter and has access to $3.5bn in undrawn credit.

McDonald's has withdrawn all previous financial guidance and will announce full first quarter results on 30th April.

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