Fitch affirms 'A' rating for McDonald's long-term IDR, bank credit facilities, senior unsecured debt, affirms 'F1' rating for company's short-term IDR, commercial paper; outlook stable
May 29, 2014
– Fitch Ratings has affirmed the ratings of McDonald's Corporation (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 digital capabilities.
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 ratings.
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 debt.
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 Subsidiary Linkage
2014 Outlook: U.S. Restaurants (Shareholder Demands to Rise, Even as Market Share Battle and Cost Pressures Continue)
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