The restaurant industry is susceptible to a wide array of risks of macro and micro factors. As a huge global brand, McDonald’s (MCD) faces several risks. Let’s look at some of them below. Later, we’ll take a look at the company’s top strengths and weaknesses.
McDonald’s profitability is tied to the execution of its strategic plan, the Velocity Growth Plan. The plan is subject to execution risk. The most important aspects of the plan relate to whether the company can stay relevant—and whether it can remain a brand that customers trust. There are many components that can drive this:
- Ability to differentiate experience that balances consumer value with margins.
- Impact pricing, marketing, and promotional plans on sales and margins.
- Ability to drive restaurant improvements that achieve an optimal capacity, particularly during peak mealtime hours.
- Motivate employees to achieve high service levels in order to improve customer perceptions.
- Ability to complete restaurant reimaging and rebuilding plans.
- The success of new menu initiatives.
- Same-store sales.
The company’s business model is built around growing comparable sales to realize margin leverage. Unfavorable economic conditions, flat or contracting IEO (informal eating out) segments in many markets, broad-based consumer caution and price sensitivity, reduced pricing power, and intense competitive activity may impact McDonald’s performance.
McDonald’s currency risks
As more than half of McDonald’s sales are from abroad, managing currency risk is pivotal to the business. Fortunately, for most of the company’s store locations, costs are denominated in the same currency as local sales. Where practical, the company’s restaurants purchase goods and services in local currencies, resulting in natural hedges.
The company’s net asset exposure is diversified among a broad basket of currencies. Its largest net asset exposures (defined as foreign currency assets minus foreign currency liabilities) at year-end were as follows.
McDonald’s total foreign currency–denominated debt was $11.8 billion at the end of 2018—that’s 38% of the company’s total debt. Further, McDonald’s earned around 65% of its operating income from outside the US in 2018. The euro, British pound, Australian dollar, and Canadian dollar represent around 80% of the company’s income outside the US.
The company’s management estimates an impact of about $0.35 on its annual earnings per share if all of these currencies moved by 10% in the same direction. A $0.35 change would indicate a 5% change in the earnings per share (or EPS) of $7.54 for 2018. Compared to other risks, financial risks can be mitigated through various hedging instruments.
Financing and market risk
McDonald’s generally borrows on a long-term basis and is exposed to the impact of interest rate changes and foreign currency fluctuations. Debt obligations at the end of 2018 totaled $31.1 billion. The debt increased in 2018 primarily due to net issuances of $2.0 billion. Standard & Poor’s currently rates McDonald’s long-term debt as BBB+ and Moody’s rates it as Baa1. Both agencies have a stable outlook on the ratings.
Debt maturing in 2019 is approximately $2.1 billion. In 2019, the company plans to issue long-term debt to refinance this maturing debt. At the end of 2018, the company also had $254 million of foreign currency borrowings outstanding, primarily under the uncommitted line of credit agreements. Neither of these amounts is material.
Based on the results of McDonald’s sensitivity analysis, a 1 percentage point adverse change in interest rates from 2018 levels would not materially affect the company’s results of operations, its cash flows, or the fair value of its financial instruments. The company uses derivative instruments to manage interest rate risks.
There have been several labor strikes and protests against McDonald’s by its workforce relating to matters such as increasing minimum hourly wages and the right to unionize. The latest example is a strike by McDonald’s staff in London. Worker strikes have also affected competitors, including Yum! Brands (YUM) and Burger King, on different occasions.
A rise in minimum wages could adversely impact McDonald’s. The impact of events such as boycotts or protests, labor strikes, and supply chain interruptions (including due to lack of supply or price increases) could also adversely affect both the company and its franchisees.
Operating in developed markets like the US and Europe, McDonald’s faces tighter regulations. Some regulatory changes include printing nutritional content on items, product packaging, taxation, and marketing to young people. This could translate into higher costs of compliance.
For example, McDonald’s committed to the EU Pledge, in which it would fulfill nutritional criteria for items advertised to kids under the age of 12. In the same effort, McDonald’s also committed to not engage in communication with primary schools in Europe.
There have been several studies and some criticism surrounding McDonald’s, on a broad range of topics such as food quality and treatment of employees. All of these contribute to changes in consumer perception of McDonald’s and its food.
Trends in food habits, such as a move toward a healthier menu, also impact sales when McDonald’s can’t keep up with demand. Introducing a healthier menu and changing the image from a junk food restaurant to a healthy food restaurant poses a huge risk due to customers’ set perceptions about McDonald’s.
Next, let’s take a look at McDonald’s key strengths and weaknesses.
McDonald’s serves about 70 million customers daily. That scale is one of the company’s key strengths. The company purchases raw materials in bulk, which helps achieve economies of scale and eventually benefits the customers through low-cost food options.
McDonald’s has pioneered restaurant chain expansion, and it enjoys this advantage around the world. Except in China, McDonald’s dominates the restaurant chain business in several major markets around the world. The first-mover advantage has equipped McDonald’s to reap the benefits because it’s the largest player in the fast-food/burger segment.
McDonald’s food has frequently been in the spotlight for its food quality and how it affects health. Documentaries such as Super Size Me garnered further negative publicity for McDonald’s. Unfortunately, this perception has cast a shadow on McDonald’s move toward a healthier menu—a trend that consumers have started to embrace.
McDonald’s and its competitors such as Burger King and Wendy’s (WEN) have very similar offerings. This puts pressure on pricing and retention efforts.
To learn about McDonald’s supply chain, please read McDonald’s Supply Chain: A Must-Know for Investors. McDonald’s is present in more than 100 countries. You can learn about its global markets in McDonald’s Global Presence and the Three-Legged Stool.
Moreover, you can learn about the company’s franchise model in Analyzing McDonald’s Franchise Agreement and Structure. If you want to know more about the company, read McDonald’s Overview: Segments, Buybacks, Valuation.
You can learn more about what analysts said after the exit of McDonald’s CEO in McDonald’s Stock: Analysts Worry after CEO Exit.
(The above post is an update of posts by Samantha Neilson and Adam Jones for Market Realist.)