McDonald's refranchising plan underwhelms analysts

29/05/2014
Company’s plan to increase shareholder cash and accelerate refranchising program lacks dramatic steps
Officials for McDonald’s Corp. raised the amount of cash the company plans to return to shareholders, paid for in part through an accelerated refranchising program, yet securities analysts gave the updated plans a tepid response.
Several industry watchers indicated that they expected more than what McDonald’s announced Wednesday at the Sanford C. Bernstein Strategic Decisions Conference, which included the company’s plan to return between $18 billion and $20 billion to shareholders between 2014 and 2016. McDonald’s also said it would refranchise at least 1,500 restaurants during that three-year span — mostly in Europe and the Asia-Pacific, Middle East and Africa, or APMEA, segment — but analysts had imagined a higher number there as well.
While the company’s chief executive, Don Thompson, and chief financial officer and corporate executive vice president, Pete Bensen, told investors during last month’s first quarter earnings call that the balance sheet would be an opportunity for McDonald’s to create value through stepping up refranchising and repurchasing, they did not indicate that the magnitude of those moves would be dramatic. This week, Thompson and Bensen gave equally measured projections in meetings with investors.

“With McDonald’s previously noting ‘urgency’ around creating short-term shareholder value via optimization of the capital, ownership and cost structure, investors’ ‘dream scenario’ had aggressive assumptions,” Jeffrey Bernstein, a director of Barclays Capital, wrote in a research note. “The updated return targets likely fell short of that scenario, more at the pace of McDonald’s.”
The Oak Brook, Ill.-based company’s new targets represent acceleration from the cash returns and refranchising accomplished from 2011 to 2013. During that period, McDonald’s returned $16.4 billion to stockholders through share buybacks and dividends, meaning the new goal between $18 billion and $20 billion could represent a three-year increase between 10 percent and 20 percent. Likewise, the refranchising of 1,500 locations to owner-operators outside the United States would be a 50-percent increase over the 1,000 units sold to franchisees over the previous three years.
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Sara Senatore, restaurant analyst for Bernstein Research, characterized the new targets as “modest, but no step change,” and more in line with McDonald’s shareholder value initiatives between 2007 and 2009, when it refranchised 1,500 units.
“McDonald’s plan to optimize capital and ownership structures is consistent with the prior iteration at the end of the last decade … rather than a dramatic departure,” she wrote in a research note. “The magnitude and pace of refranchising represent an increase over the past three years, but consistent with the period previous to that and modestly slower than the 3,000-unit target some investors had anticipated.”
Also modest is the implied increase in debt McDonald’s likely would have to take on in order to give back as much as $20 billion over the next three years, given its free cash flow of about $4.5 billion per year, Senatore added. She and Bernstein of Barclays both noted that the company could borrow an additional $1 billion to $2 billion without risking its “A” credit rating, and they both agreed that the refranchising program could net about $1 million per unit, or about $1.5 billion.
Senior analyst David Tarantino of Robert W. Baird & Co. noted that McDonald’s officials suggest the company “may not need to increase financial leverage meaningfully to achieve this goal, given healthy operating cash flows, stable capital expenditure projections and expected refranchising proceeds.”
The refranchising goals would lift the total percentage of worldwide franchise-operated restaurants for McDonald’s from its current level of 81 percent to as high as 85 percent, mostly by inching Europe and APMEA upward from their current levels of 73 percent and 71 percent, respectively. By comparison, franchisees operate 89 percent of McDonald’s more than 14,000 locations in the United States.
High-growth markets China and the United Kingdom are expected to lead the refranchising charge.
“We expect the transition to a higher global franchise mix to result in an even more stable and less asset-intensive business model,” Tarantino wrote, “while generating cash from refranchising proceeds to fund dividends and buybacks — possibly more than offsetting the impact from any margin dollar declines associated with selling company stores to franchisees.”
McDonald’s Corp. operates or franchises more than 35,000 restaurants in more than 120 countries.
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By: http://nrn.com/franchising

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