Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) of
McDonald's Corporation (NYSE: MCD) at 'A/F1'. The Rating Outlook
has been revised to Negative from Stable.
At Dec. 31, 2014, McDonald's had approximately $15 billion of
total debt. A full list of ratings is provided at the end of this
release.
Negative Outlook:
The Outlook revision is due to persistently weak global
same-store sales (SSS), declining store-level profitability, and
increased leverage. Global SSS were negative 1% in 2014, after
being flat at 0.2% in 2013, with guest counts declining 1.9% in
2013 and 3.6% in 2014. Consolidated company-operated restaurant
margin contracted 160 basis points to 15.9% in 2014, continuing a
multi-year decline that began in 2010. Lastly, total debt/EBITDA
and total adjusted debt/EBITDAR were 1.5x and 2.6x, respectively,
at Dec. 31, 2014 up from 1.4x and 2.4x in 2013.
Fitch's current rating incorporated that total debt/EBITDA and
total adjusted debt/EBITDA (rent-adjusted leverage) would
approximate 1.5x and 2.5x, respectively, while considering
McDonald's leading global market position, brand strength, system
health, and significant financial flexibility. However, recent SSS
trends, market share losses, and the decline in operating income
results in little room for further downside.
The modest increase in leverage during 2014 was due to an 8%
decline in constant currency operating income and $1.5 billion of
incremental debt to help fund the company's $18 - $20 billion
three-year cash shareholder return target. Fitch's base case
projection is that total debt/EBITDA and rent-adjusted leverage
will increase to 1.6x and 2.7x, respectively, in 2015 and 2016 due
to flat SSS, limited operating income growth and modestly higher
debt to partially finance share repurchases.
Fitch believes McDonald's sales will gradually benefit from
increasing real disposable income in the U.S., particularly for
low-to-middle income consumers, and brand-level initiatives around
the world but views continued market share losses as likely in
2015. Restaurant margins will also remain pressured given weak
sales and rising U.S. labor costs. Pricing remains limited due to
relatively low inflation, heightened competition, and still weak
economic conditions in most of Europe (which represented 40% of
revenue and 41% of operating income in 2014). McDonald's expects
modest 1.5% - 2% commodity inflation in the U.S. and Europe for
2015.
KEY RATING DRIVERS
Same-Store Sales and Market Share Trends
As mentioned previously, McDonald's ratings incorporate its
position as the world's largest restaurant chain, with about $88
billion in system sales, 36,000 plus units, and over $27 billion of
revenue. However, global SSS have been weak for two consecutive
years. Market share losses have occurred in the U.S. but, according
to the company, trends vary across Europe.
McDonald's attributes economic conditions, heightened
competition, and unanticipated business interruptions caused by a
supplier issue affecting the Asia Pacific, Middle East, and Africa
(APMEA) segment, and temporary store closures in Russia for its
challenges. Fitch also views modest slippage in restaurant service,
less effective promotions, and negative perceptions regarding the
brand's food among certain consumer demographics that prefer less
processed food with fresh ingredients as drivers. McDonald's
intensified its focus on value in 2013 and 2014 in order to drive
traffic but annual guest counts became increasingly negative across
most major geographies.
Effectiveness of Brand Initiatives
McDonald's new CEO, officially as of March 1, is expected to
accelerate efforts to improve the brand image globally. In December
2014, the company detailed a strategy to regain SSS growth in its
core U.S. market. Plans entail simplifying the menu to improve
service and address local customer preferences, and creating the
Experience of the Future which includes, among other initiatives, a
new Create Your Taste (CYT) customizable burger platform.
McDonald's also remains focused on improving SSS in other priority
markets including Germany, Japan, and Australia.
Fitch views a cohesive and aggressive system-wide effort to
improve service, emphasize food quality, and provide
locally-relevant menu variety as necessary catalysts for SSS
growth. McDonald's plan to launch CYT in the up to 2,000 U.S.
restaurants by the end of 2015 will likely have a limited near-term
positive impact on the company's image in the burger category as it
only represents 14% of total domestic locations. McDonald's brand
recovery efforts in Japan will also take time to resonate with
consumers because of a high level of competition, particularly in
the convenience channel, and food quality incidents beyond the July
2014 APMEA supplier challenge.
Substantial but Decelerating Cash Flow Growth
McDonald's generates substantial cash flow from operations at
$6.7 billion in 2014. CFO declined 5% in 2014 due to lower sales
and operating income, after growing at an 8% CAGR from the launch
of the firm's Plan to Win strategy in 2003 to $7.1 billion in 2013.
Free cash flow (FCF - defined as CFO less capex less dividends)
remained meaningful at $931 million due to lower capex but was
below the company's annual average of $1.5 billion from 2010 to
2013.
Fitch expects CFO trends to stabilize in 2015 and then grow at a
low single-digit rate in 2016. FCF in 2015 will be enhanced by
reductions in capex as McDonald's slows unit growth in its most
challenged countries and focuses on regaining sales momentum but
debt reduction is not anticipated.
McDonald's expects to spend about $2 billion in capex during
2015, down from $2.6 billion in 2014 and the lowest level in five
years. Capex will be allocated roughly 50/50 between new units and
reinvesting in existing locations, as modernizing the customer
experience remains a key global priority. Net restaurant additions
will be between 600 and 700, representing about 1.8% expansion in
2015.
Increasingly Aggressive Financial Strategy
Fitch views McDonald's financial strategy as increasingly
aggressive given negative SSS trends and the loss of market share.
McDonald's has publicly reiterated plans to return $18 billion -
$20 billion in aggregate dividends and share repurchases from 2014
through 2016, a 10% - 20% increase versus payouts during the
three-years ended 2013, despite weaker than expected operating
results. Fitch views McDonald's reduction of new unit capex as
prudent given weak sales and declining margins. As mentioned
previously, FCF will be enhanced, but debt reduction is not
anticipated.
Cohesive Operating Framework, Franchising
Fitch believes the continued alignment of corporate, franchisees
and suppliers to meet customer needs as critical to McDonald's
success. The company's significant scale is a benefit, providing
bargaining power with procurement, unmatched advertising
capability, and convenient locations for consumers. However, the
ability to quickly adjust to consumer trends is likely difficult
due to its massive infrastructure.
McDonald's 81%/19% global mix of franchised to company stores at
Dec. 31, 2014 supports cash flow, augments corporate margins, and
assists with the rollout of new system initiatives. High-margin
royalties and contractual rent payments from franchising
represented 34% of revenue in 2014. McDonald's is on track to
refranchise 1,500 units from 2014 to 2016, mainly across Europe and
APMEA, but its ownership mix is not expected to change materially
leaving company-owned stores directly exposed to rising costs.
McDonald's owns roughly 45% of the land and about 70% of the
buildings within its system. Fitch believes the company's strong
asset base solidifies its relationship with franchisees, increases
the stability of its cash flow, reduces contingent liabilities, and
distinguishes McDonald's from its peers.
Financial Flexibility, Liquidity, and Maturities:
McDonald's financial flexibility is supported by its substantial
operating cash flow, good FCF generation, ready market access, and
high level of liquidity. At Dec. 31, 2014, McDonald's had $4.6
billion of liquidity consisting of $2.1 billion of cash, of which
$1.2 billion was held offshore, and availability under an undrawn
$2.5 billion committed revolver expiring December 2019. The company
had $200 million of commercial paper (CP) outstanding under its
$2.5 billion CP program at year end.
About 60% of McDonald's $15 billion of debt at Dec. 31, 2014 was
U.S. denominated and 40% was foreign denominated. Upcoming debt
maturities approximated $1.1 billion in 2015, $823 million in 2016,
and $1 billion in 2017 based on year-end foreign exchange rates.
Fitch views maturities as manageable given McDonald's strong market
access and annual FCF. McDonald's plans to refinance its 2015
maturities.
KEY ASSUMPTIONS
--SSS are flat in 2015 and growth resumes to the low
single-digit level by 2016;
--Company-operated restaurant margins stabilize by 2016;
--Operating cash flow stabilizes in 2015 and grows at a low
single-digit rate thereafter;
--Total debt-to-operating EBITDA and total adjusted
debt-to-operating EBITDAR (defined as total debt plus 8x gross
rents-to-operating EBITDA plus gross rents) approximates 1.6x and
2.7x, respectively, in 2015 and 2016;
--FCF approximates $1 billion or more annually.
RATING SENSITIVITIES
Future developments that may, individually or collectively, lead
to a negative rating action include:
--If Fitch ascertains that global SSS will be negative in 2015
and market share trends do not stabilize;
--Management demonstrates an unwillingness to pull back on share
repurchases if sales trends continue to deteriorate;
--Total debt-to-operating EBITDA and total adjusted
debt-to-operating EBITDAR sustained above 1.5x and 2.5x,
respectively.
Future developments that may, individually or collectively, lead
to a positive rating action include:
--An upgrade is not likely in the near term, given recent weak
SSS trends, on-going margin contraction, and increased leverage;
--The Rating Outlook could be revised to Stable if SSS are better
than Fitch anticipates, market share trends stabilize, or leverage
is maintained below current levels.
Fitch has affirmed its ratings on McDonald's as follows:
--Long-term 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 has been revised to Negative from Stable.
Additional information is available at
'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 2014);
--'2015 Outlook: U.S. Restaurants - Bucking the Status Quo,
Brands Transform to Satisfy Astute Diners, Arduous Investors'
(December 2014);
--'McDonald's Corporation - Ratings Navigator' (February
2015).
Applicable Criteria and Related Research:
2015 Outlook: U.S. Restaurants (Bucking the Status Quo, Brands
Transform to Satisfy Astute Diners, Arduous Investors)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=839828
Corporate Rating Methodology - Including Short-Term Ratings and
Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=980723
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Fitch RatingsPrimary AnalystCarla Norfleet Taylor, CFASenior
Director+1-312-368-3195Fitch Ratings, Inc.70 W. Madison
StreetChicago, IL 60602orSecondary AnalystJudi M. Rossetti,
CFA/CPASenior Director+1-312-368-2077orCommittee ChairpersonMichael
WeaverManaging Director+1-312-368-3156orMedia Relations:Alyssa
Castelli, New York, +1 212-908-0540Email:
alyssa.castelli@fitchratings.comElizabeth Fogerty, New York, +1
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