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【October 2024】How to view the performance of the global largest fast food chain empire, McDonald's?
When it comes to the dominant force in the global dining industry, it's none other than McDonald's. In terms of the number of restaurants, $McDonald's (MCD.US)$ 's chain stores exceed 0.04 million, surpassing all globally; in terms of market cap, McDonald's US market cap exceeds 200 billion US dollars, also leading the industry by a large margin.
At the same time, McDonald's takes a somewhat unconventional approach: as the leader in the dining industry, it primarily earns money by renting out properties, and despite being the company with the largest market cap in the industry, shareholder equity is negative.
Although McDonald's seems a bit unconventional, it does not affect its historical stock price trend's ability to keep up with the rise of the S&P 500 index. How should we evaluate the performance of such a company?
On October 29th, McDonald's will release its performance report. Each time the company releases its performance, it may also mean a good trading or investment opportunity. Before that, investors need to understand how to interpret its performance. When it comes to McDonald's performance, we can observe it from three common perspectives: revenue growth, profitability, and shareholder returns.
1. Revenue growth
For chain restaurant companies, their revenue growth is mainly driven by two aspects.
One is the increase in the number of stores. During periods of rapid store expansion, it may also be a period of rapid growth for chain enterprises. Conversely, if the number of stores continues to shrink, revenue growth is also less optimistic.
Secondly, the growth of same-store sales is important. With a constant number of stores, if each store can maintain growth in revenue compared to the stores, it can also drive revenue growth. Conversely, if same-store sales decline, it will inevitably bring pressure on revenue growth.
Of these two indicators, same-store sales may be particularly important. If same-store sales maintain rapid growth, it may indicate that the company's brand momentum is strong, and there is still room for significant improvement in regional coverage and market penetration. Even with additional store openings, the impact on existing store traffic may not be significant. Conversely, if same-store sales are declining, further store openings may further reduce existing store traffic. Therefore, only when same-store sales maintain good growth can chain enterprises possibly accelerate store openings and drive revenue growth.
How about McDonald's situation in these two indicators?
In terms of same-store sales, over the 10-year period from 2014 to 2023, McDonald's saw growth in most years, although it dropped significantly by about 7.7% in 2020 due to the impact of the pandemic, but rebounded significantly in the following three years. However, in terms of growth rate change, McDonald's same-store sales growth has slowed down, with only about 1.9% in the 2024 fiscal year Q1 quarter, continuing to decline in the 2024 Q2 quarter, with a decrease of about 1% year-on-year.
Looking at the number of stores, McDonald's global total number of stores increased from 36,258 in 2014 to 41,822 by the end of 2023, with annual growth over the 10-year period. It has increased by more than 5,000 stores, an average annual increase of about 1.6%, showing a very steady pace of store expansion.
Overall, McDonald's maintains a good growth trend in both same-store sales and store numbers. So how about its revenue growth? Surprisingly, it is declining, from $27.44 billion in 2014 to $25.49 billion in 2023. Why is this happening? It is mainly due to changes in McDonald's operating model, which may not be a bad thing.
McDonald's stores include two types: company-owned stores and franchise stores. For company-owned stores, all income goes to the company; for franchise stores, McDonald's collects initial franchise fees, royalty fees, and rental income as the brand owner, with this income accounting for only a small part of store revenue.
In 2014, of McDonald's 36,258 stores, although company-owned stores accounted for less than 20%, since income from company-owned stores is fully booked, it accounts for the majority of revenue. In 2014, company-owned store revenue was approximately $18.2 billion, accounting for about 2/3 of all revenue.
Starting from 2014, McDonald's began selling company-owned stores to franchisees to reduce the proportion of company-owned stores. By 2023, McDonald's only had 2,142 company-owned stores left, accounting for only about 5% of the total, and its contribution to revenue was less than 40%.
Therefore, despite the continuous increase in the total number of stores, the overall revenue contraction is reasonable due to the significant reduction in company-owned stores that previously contributed the most to revenue.
Overall, for McDonald's future revenue growth trend, if its company-owned stores continue to decrease, we can weaken its overall revenue growth in the short term. However, we still need to focus on the growth of same-store sales and the expansion of all store numbers. This is the foundation of its long-term revenue growth trend. Looking at the situation in the first two quarters of this year, McDonald's same-store sales performance was relatively weak. We should continue to monitor this data in subsequent quarters.
2. Profitability
The ultimate goal of company operation is to make money, to achieve actual net income. McDonald's is willing to endure the risk of continuous revenue decline and continue to reduce company-owned stores while expanding the scale of franchise stores because of this structural adjustment. This is more conducive to enhancing profitability and net income levels.
Although company-owned stores have a large revenue scale, they have to bear costs such as ingredients, rent, utilities, and labor, with very limited profit margin.
While individual franchise stores contribute less revenue, McDonald's collects franchise fees and royalties without much cost, and also receives nearly 2/3 of rental income from franchise stores. McDonald's generally obtains stores at a lower rent through its own brand influence and long-term leasing commitments, and then sublets them to franchisees, resulting in a very considerable profit margin.
Taking 2023 as an example, McDonald's company-owned stores have a gross margin of only 15.6%, while the franchise module has a gross margin as high as 83.9%. The gross profit contributed by franchise business accounts for nearly 90% of the company's overall gross profit. Therefore, with the significant increase in the proportion of franchise stores, McDonald's profitability has also increased significantly.
In terms of gross margin, starting from 2014 when McDonald's began to continuously reduce the number of self-operated stores, its gross margin increased from 38.1% to 57.1%, a significant increase of 19 percentage points. During the same period, its net profit margin also increased from 17.3% to 33.2%, a substantial increase of about 16 percentage points. Since 2014, McDonald's has started to sell self-operated stores to franchisees, reducing the proportion of self-operated stores. By 2023, McDonald's only had 2,142 self-operated stores left, accounting for only about 5%, and their contribution to revenue was less than 40%.
Therefore, despite the continuous increase in the total number of stores, it is reasonable that the overall revenue of McDonald's has declined significantly due to the significant reduction of self-operated stores that previously contributed the most to revenue.
In general, for McDonald's future revenue growth trends, if its self-operated stores continue to decrease, we may weaken its overall revenue growth in the short term. However, we still need to focus on the growth of same-store sales and the expansion of the number of all stores. This forms the foundation of its long-term revenue growth trends. Looking at the situation in the first two quarters of this year, McDonald's same-store sales have been relatively weak. We can continue to monitor the changes in this data in the subsequent quarters.
2. Profitability
The ultimate goal of company operations is to make money, to realize actual net income. McDonald's is willing to endure the risk of continuous revenue decline and continue to reduce self-operated stores while expanding the scale of franchise stores because such structural adjustments are more conducive to improving profitability and net income levels.
Although self-operated stores have a large revenue scale, costs such as ingredients, rent, utilities, and labor all have to be borne by themselves, leaving very limited profit margin.
While individual franchise stores may contribute less revenue, McDonald's charges franchise fees, royalties, without much cost. They also occupy nearly two-thirds of the rental income from franchise stores. Generally, McDonald's leverages its brand influence and long-term lease commitments to obtain store premises at lower rents, then subleases them to franchisees, resulting in a very substantial profit margin.
Taking 2023 as an example, McDonald's self-operated store gross margin was only 15.6%, while the franchise module gross margin was as high as 83.9%. The gross profit contributed by the franchise business accounted for nearly 90% of the company's overall gross profit. Therefore, against the backdrop of a significant increase in the proportion of franchise stores, McDonald's profitability has also increased significantly.
In terms of gross margin, starting from the reduction of self-operated stores in 2014, McDonald's gross margin increased from 38.1% to 57.1%, a significant increase of 19 percentage points. During the same period, its net income margin increased from 17.3% to 33.2%, also a substantial increase of about 16 percentage points.
Therefore, although McDonald's revenue declined during the period, its net income increased from $4.76 billion in 2014 to $8.47 billion in 2023, a growth of approximately 78% over a period of ten years, showing a relatively stable growth rate.
In future performance, we can continue to observe whether McDonald's gross margin and net income margin trends can continue to rise, thereby driving the continuous growth of net income.
3. Shareholder Returns
In the U.S. stock market, many companies, after entering a stable growth phase, use excess cash on hand for shareholder returns, mainly through buybacks and dividends. However, like McDonald's, which has taken shareholder returns to the extreme, there may not be many companies.
Since the reduction of self-operated stores in 2014, McDonald's has embarked on a generous cash distribution model, with dividends and repurchases exceeding net income for six consecutive years. For example, in 2017, McDonald's net income was $4.69 billion, but the combined amount for dividends and repurchases was as high as $14.23 billion.
From 2014 to 2023, McDonald's accumulated net income was $58.01 billion, but the accumulated dividends and repurchases amounted to as high as $79.85 billion, significantly exceeding the net income level over the period.
Under the operation of 'emptying the coffers' to reward shareholders, McDonald's net assets turned negative since 2016, reaching approximately -$-4.7 billion in 2023.
A net negative asset means that McDonald's is already in a state of insolvency. Is this not a sign of bankruptcy? There's no need to worry too much about that.
First of all, McDonald's insolvency is not due to poor management but rather a choice made by the company. Because the vast majority of McDonald's stores are franchise stores, as the brand, McDonald's can be said to be relatively stable. With smaller operational risks, it's just a matter of making more or less money, without the need to reserve too much cash to withstand potential economic risks.
At the same time, the main reason for a company's bankruptcy is not typically insolvency but rather a breakdown in cash flow. McDonald's free cash flow is positive every year, so relatively speaking, it is still quite healthy.
In future performance, we can continue to observe the sustainability of McDonald's high dividends and repurchases, as well as whether its free cash flow can maintain a relatively healthy level.
By now, you may have gained some new insights on how to interpret McDonald's performance. It's worth mentioning that every time a high-profile company releases its performance, it may represent a rare trading opportunity for different types of investors.
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Conversely, if investors believe that the latest performance of a certain company will not be optimistic and will bring pressure on the short-term stock price, investors may consider short selling, which can be done by considering margin selling or buying put options.
Of course, if investors feel uncertain about the bullish or bearish direction of a company's performance, but the stock price may experience significant upward or downward volatility after the performance announcement, investors may consider capturing potential opportunities by trading the volatility of its stock price, considering employing a straddle strategy by purchasing both call and put options simultaneously.
Finally, to summarize,
When it comes to McDonald's performance, we can focus on its revenue growth, profitability, and shareholder returns.
Regarding McDonald's revenue growth, we can pay attention to its same-store sales growth and store expansion.
In terms of McDonald's profitability, we can focus on the improvement of its gross margin and net profit margin, as well as the resulting growth in net income.
For McDonald's shareholder returns, we can monitor the stability of its dividends and buybacks, as well as its level of free cash flow.
Every time a company releases its earnings, it may bring potential trading opportunities. Investors can consider suitable types of trades based on their individual risk tolerance.