Time to tuck in to McDonald’s

(Image credit: Getty Images)

published 24 August 2023

It could be time to snap up some shares in McDonald's as the fast-food chain continues to expand around the world.

In fact, the largest restaurant chain in France, the home of gastronomy and haute cuisine, is McDonald’s. Perhaps this shouldn’t really be a surprise: young French people like eating burgers as much as anybody else.

And it’s not just the French that see the good side of McDonald’s. Last year my daughter started bringing our new grandson over to see us quite regularly, and for these visits we had lunch at home and then a take-away snack.

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I was so impressed by our local branch that I bought some shares in the parent company last year at $240, partly on the basis that the cost of living crisis and rising inflation may help McDonald’s at the expense of other restaurants.

The group is the largest restaurant operator in the world – a truly global business with a 55-year international operating history. It has nearly 40,000 outlets in over 100 countries, of which 95% are franchised.

The franchised outlets deliver a steady stream of both fee income and rents – the properties are either owned by McDonald’s or on long leases – and this steady income brings stability to revenue and profits.

McDonald’s total annual revenue is more than $23bn, roughly 60% of which comes from franchisee royalty fees and rental payments.

McDonald's has a wide moat

The restaurant business generally has low barriers to entry. McDonald’s is an exception, with a wide moat formed by its strong brand and large scale.

This gives it hefty purchasing power – enabling volume discounts and lower commissions to companies such as Uber Eats – and allows substantial marketing and technology investment, which still forms only a small proportion of revenue.

The franchising model is highly profitable, with operating margins (operating profit to sales) at 44.6% last year, compared with Coca-Cola’s at 28% or Apple’s at 30.2%.

Management’s “accelerating the arches” growth strategy focuses on the “four Ds” – delivery, digital, drive-through and development.

Examples of this strategy are the company’s mobile app, loyalty programme, and emphasis on order automation and suggestive selling.

Some 40% of sales in its six core markets now come through digital channels. These and other initiatives are leading to market share gains, store sales growth and a strong store development pipeline.

Rewarding franchisees

In the US, McDonald’s averaged sales per franchised restaurant of $3.6m in 2022, compared with $1.4m for Burger King and $1.9m for Wendy’s. Given that stores have substantial fixed costs, higher revenue per store flows through to higher profitability compared with rivals.

McDonald’s return on invested capital (ROIC) has been 18% over the last five years, which include the pandemic year of 2020, when ROIC fell to 14%. Crucially, this model delivers decent returns to franchisees, who earn mid teens cash returns on their cash outlays, reckons Morningstar.

The group’s strong brand is important for attracting new franchisees, since it helps new units reach average unit sales more quickly. McDonald’s scale also enables it to provide franchisees with one-off help such as the $100m-$150m used in 2023 to help European franchisees cope with high food cost inflation.

Rent holidays in 2020 are another example of help to franchisees, who are encouraged to invest in long-term customer relationships to grow market share for them and for McDonald’s.

Steady growth in capital and income

McDonald’s is one of those world-class companies in a stable sector that gives steady capital growth with a growing dividend.

Over the past five years, the shares are up by 77%, while the dividend has almost doubled in the past ten years. The company reported revenue of $23.2bn in 2022 and operating profit (ie, before interest and tax) of $10.34bn.

McDonald’s has increased its dividend every year since 1997 and the current quarterly dividend of $1.52 puts it on a forward dividend yield of 2.17%, based on a share price of $280 at the time of writing.

The trailing price/earnings (p/e) ratio is 25.8, while the p/e ratio based on forecast earnings for 2033 is 24.3, according to estimates compiled by Bloomberg.

Highly qualified (BSc PhD CPhys FInstP MIoD) expert in R&D management, business improvement and investment analysis, Dr Mike Tubbs worked for decades on the 'inside' of corporate giants such as Xerox, Battelle and Lucas. Working in the research and development departments, he learnt what became the key to his investing; knowledge which gave him a unique perspective on the stock markets.

Dr Tubbs went on to create the R&D Scorecard which was presented annually to the Department of Trade & Industry and the European Commission. It was a guide for European businesses on how to improve prospects using correctly applied research and development. He has been a contributor to MoneyWeek for many years, with a particular focus on R&D-driven growth companies.