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Naman Shukla
Naman Shukla
Articles (216) 

Is it Time to Book Profit on McDonald's?

The fast-food juggernaut's transition to franchisees will improve profit margins

June 17, 2017 | About:

McDonald’s Corp. (NYSE:MCD) rewarded investors with trifling returns in 2016, but the stock has displayed strong signs of upward momentum this year. It is up approximately 25% year to date. The company reported strong first-quarter earnings last month which worked as a catalyst for the stock to move upward.

McDonald’s impressive first-quarter results not only pushed the stock higher but also forced several analyst firms, such as Mizuho, to raise its price target on McDonald's. Moving onward, the fast-food giant recently publicized that it plans to expand its current delivery program in the United States, including locations in the New York area, from 2,000 restaurants to 3,500 by the end of this month to find a significant new source of growth.

The company is relying on an online meal ordering and delivery platform, UberEATS, to handle the McDelivery program. UberEATS usually charges $5 as a booking fee which can also vary by location. The company’s initiative to deliver burgers to its customers is part of its attempt to reinvent itself as a more contemporary burger chain.

On the other hand, McDonald’s plans to sell off more company stores, with the aim of 4,000 for this year. The fast-food giant is doing so keeping in mind the profitability of business owned by franchisees. As a matter of fact, most of the company’s revenue comes from the restaurant base it directly owns and operates.

In 2016, the company’s owned restaurant generated $15.3 billion of sales compared to $9.3 billion from franchisees. However, the situation is entirely different when you look at the bottom-line. The company’s owned restaurants produced just $2.6 billion of profits whereas its franchisees generated more than $7.5 billion.

The fast-food giant’s long-term goal is to have franchisees account for 95% of the stores as it will considerably improve profit margins without having much in the way of expenditures. Additionally, operating costs will also come down which will have a positive impact on operating margin. The company’s management was able to deliver on its growth strategy which is reflected in its share price.

When it comes to the dividend, McDonald’s has a strong growth track record. Since 1976, the company has successfully managed to increase its dividend every year and currently offers a healthy forward dividend yield of 2.47%.

One of the most significant problems with McDonald’s is its long-term debt. As the fast-food giant refranchises, buys back shares, as well as pays out its dividend, it is continuously increasing its long-term debt load. Its long-term debt currently sits at approximately $27 billion which has degraded the quality of its balance sheet.

Conclusion

McDonald’s has been displaying fiery growth recently, trading near its all-time high after its recent earnings report topped analyst’s expectations with a variety of metrics, comprising the all-important same-store sales.

The company is making a smart move by expanding its delivery service as it could substantially improve the sales. However, there are several risks associated with the successful implementation of such plans. Moreover, it is likely that the expansion of delivery program may not lead to the expected surge in consumption.

Apart from the delivery service, McDonald’s should also introduce mobile order and pay service to compete effectively against its rivals.

All in all, McDonald’s still has a long road ahead. The company’s transition from owned restaurant to franchisees will decrease costs and improve cash flow generation. As an outcome, long-term investors should continue holding the stock as its growth prospects look healthy.

Disclosure: I do not hold a position in the stock mentioned in this article


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