Fitch Affirms McDonald's IDRs at 'A/F1' on Shareholder Return Plan; Outlook
CHICAGO -- May 28, 2014
Fitch Ratings has affirmed the ratings of McDonald's Corporation (NYSE: MCD)
after the firm's three-year total cash return announcement. Fitch has affirmed
the ratings as follows:
--Long-term Issuer Default Rating (IDR) at 'A';
--Bank credit facilities at 'A';
--Senior unsecured debt at 'A';
--Short-term IDR at 'F1';
--Commercial paper at 'F1'.
The Rating Outlook is Stable. At March 31, 2014, McDonald's had $13.9 billion
of total debt.
Key Rating Drivers:
Three-Year Total Cash Shareholder Return Target
The affirmation of McDonald's ratings follows the company's announcement that
it intends to return $18 billion - $20 billion of cash to shareholders between
2014 and 2016 through a combination of dividends and share repurchases. The
commitment represents a 10% - 20% increase over the $16.4 billion returned
over the 2011 - 2013 year period. The firm also expects to refranchise at
least 1,500 restaurants and reallocate resources related to general and
administrative expenses toward higher return initiatives, including its
McDonald's financial strategy has consistently been to reinvest in its
business, return cash to shareholders, and maintain credit statistics
appropriate for an 'A' credit rating.
The firm has not articulated how much incremental debt it will incur to fund
its three-year return commitment. However, Fitch believes the vast majority
will be funded with internally generated cash flow, proceeds from
refranchising, and other sources of liquidity in order to maintain current
Fitch projects that McDonald's can generate over $21 billion of cumulative CFO
during the three-year period ended 2016. Management expects capital
expenditures to be between $2.9 billion and $3 billion in 2014 but has not
provided guidance for subsequent years. Potential proceeds from refranchising
have not been disclosed. McDonald's last major refranchising transaction was
the sale of 1,571 units in Latin America during 2007, which resulted in $648
million of net proceeds.
Credit metrics are expected to remain acceptable for current ratings but a
slight increase in leverage would eliminate room to accommodate additional
weakening of same-store sales (SSS), operating income, and margins. Two years
of flat to negative global SSS and continued margin contraction concurrent
with a material increase in debt could lead to a negative rating action.
Substantial Cash Flow Generation
McDonald's cash flow from operations (CFO) has grown at an 8% compound annual
growth rate since 2003 to $7.1 billion in 2013. CFO growth slowed recently due
to more modest sales and operating income growth but remains substantial. Free
cash flow (FCF - defined as cash flow from operations less capital
expenditures and dividends) has averaged $1.5 billion since 2003. A
re-acceleration of operating earnings and cash flow growth, driven by
McDonald's efforts to reignite SSS, would minimize any incremental debt
required to meet its three-year return target.
Strong Global Market Position
McDonald's is the world's largest restaurant company based on nearly $90
billion of system-wide sales and a widely respected brand. At Dec. 31, 2013,
the system had 35,429 worldwide units and during the year McDonald's generated
$28.2 billion of total revenue and $8.8 billion of operating income. The
firm's geographic segments and their percentage of 2013 revenue and operating
income were: the U.S. (32% and 43%), Europe (40% and 38%), APMEA
(Asia/Pacific, Middle East, and Africa) (23% and 17%), and Other Countries and
Corporate (5% and 2%).
Significant Franchise Revenue
At Dec. 31, 2013, franchisees and affiliates operated 81% of McDonald's units
while the remaining 19% were company-operated. Revenue from franchising
totaled $9.2 billion or 33% of McDonald's total revenue in 2013. Revenue from
franchising includes sales-based royalties and contractual rent payments.
McDonald's owns about 45% of the land and 70% of the buildings for its system
of restaurants. Net property and equipment had a book value of $25.7 billion
at Dec. 31, 2013. Fitch views McDonald's plan to refranchise at least 1,500
units with an emphasis on APMEA and Europe favorably but expects the firm to
continue to operate a material percentage of its units.
Proven Operating Strategy
McDonald's three global priorities include optimizing its menu, modernizing
the customer experience, and broadening accessibility to its brand. Annual
global SSS have only declined twice since 1997, despite multiple economic
recessions. McDonald's long-term, average annual constant currency financial
targets include 3% - 5% system sales and 6% - 7% operating income growth.
Fitch views McDonald's system sales goals as achievable given the firm's net
restaurant expansion. Management expects net restaurant additions of 949
units, in line with the increase in 2013, to add about 2.5% to system-wide
sales in 2014. Operating income growth, however, could continue to be below
target levels over the near term as costs continue to rise and efforts to
regain SSS momentum take time to resonate with consumers. For 2014, McDonald's
expects commodity costs to increase 1% - 2% in the U.S. and Europe.
First Quarter 2014 Operating Performance:
McDonald's revenue increased 3% to $6.7 billion and operating income rose 1%
to $1.9 billion on a constant currency basis during the first quarter ended
March 31, 2014. Global SSS grew 0.5% reflecting higher average check and a
3.1% decline in guest counts. SSS in the U.S. were negative 1.7% while
comparable sales growth was positive 1.4%, 0.8%, and 6.1% in Europe, APMEA,
and the Other Countries and Corporate segment, respectively.
McDonald's combined operating margin declined 60 basis points (bps) versus the
2013 comparable quarter to 28.9%. The decline was due mainly to lower margins
in franchise operations. Franchise margin fell 60 bps to 81.1% due mainly to
negative SSS in the U.S. and higher rent expense in Europe, and APMEA. Global
company-operated restaurant margin declined 10 bps to 16.1%.
Fitch believes an intensified focus around customer service along with
continued emphasis on value and menu variety will help McDonald's regain SSS
momentum by late 2014. The firm is focused on improving traffic trends across
the U.S., Germany, Australia, and Japan and is investing in reimaging and
other efforts to reconnect with and remain relevant to consumers.
For the latest 12 month period ended March 31, 2014, total debt-to-operating
EBITDA and rent-adjusted leverage (total debt plus eight times gross rent
expense divided by EBITDA plus gross rents) were 1.4x and 2.4x, respectively.
Rent-adjusted interest coverage (EBITDAR divided by gross interest expense
plus gross rent) was 4.6x and funds from operations (FFO) fixed charge
coverage was 3.9x. McDonald's FCF margin to sales was 5.1%.
Significant Liquidity, Manageable Maturities:
McDonald's liquidity at March 31, 2014, totaled $4.2 billion and consisted of
$2.7 billion of cash and full availability under the firm's undrawn $1.5
billion committed revolver, which expires Nov. 1, 2016. Aggregate maturities
of long-term debt as of March 31, 2014 were zero in 2014, approximately $1.2
billion in 2015 and roughly $900 million in 2016. About 60% of the firm's
$13.9 billion of debt at March 31, 2014 was U.S. denominated and roughly 40%
was foreign denominated.
Future developments that may, individually or collectively, lead to a positive
rating action include:
--An upgrade is not anticipated in the intermediate term given McDonald's
recent SSS trends, margin contraction, and plan to partially finance share
buybacks with incremental debt.
Future developments that may, individually or collectively, lead to a negative
rating action include:
--Total debt-to-operating EBITDA and rent-adjusted leverage sustained over
approximately 1.5x and 2.5x, respectively, and materially lower FCF;
--Two years of flat to negative global SSS and continued margin contraction;
--Weak or declining operating cash flow concurrent with meaningful incremental
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (August 2013);
--'2014 Outlook: U.S. Restaurants - Shareholder Demands to Rise, Even as
Market Share Battle and Cost Pressures Continue' (December 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and
2014 Outlook: U.S. Restaurants (Shareholder Demands to Rise, Even as Market
Share Battle and Cost Pressures Continue)
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Carla Norfleet Taylor, CFA, +1-312-368-3195
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
Judi M. Rossetti, CFA, CPA, +1-312-368-2077
Wesley E. Moultrie II, CPA, +1-312-368-3186
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