McDonald’s Revenue Hurt by Refranchising Woes

Revenue fell 5% to $6.02 billion for the tenth straight quarter

McDonald’s Corp. (NYSE: MCD), the world’s largest fast food provider, announced its Q4 FY16 and full year FY16 financial results on January 23rd, 2017.

The Oak Brook, Illinois-based Company operates and franchises McDonald’s restaurants. The Company’s segments include US, International Lead Markets, High Growth Markets and Foundational Markets and Corporate. Of the approximately 36,525 restaurants in over 120 countries, roughly 30,080 are franchised and over 6,444 are operated by the Company.

McDonald’s International Lead Markets include Australia, Canada, France, Germany, the UK, and related markets. Its High Growth Markets include China, Italy, Korea, Poland, Russia, Spain, Switzerland, the Netherlands, and related markets. The Foundational markets span over 80 countries across Asia, Europe, Latin America, the Middle East, and Africa. Read more about McDonald’s financial results below.

Q4 FY16 financial highlights

During Q4 FY16, McDonald’s total revenue fell 5% to $6.02 billion and 3% in constant currencies from $6.34 billion in the year-ago same period, down for the 10th straight quarter due to the impact of the Company’s refranchising efforts. McDonald’s aims to drastically reduce the number of stores it owns in favor of franchises. As part of this move, only 10% of McDonald’s stores will be company-owned by 2018. Currently, 80% of its restaurants are franchisee-owned. McDonald’s is also selling about 3,500 of its 36,000 restaurants as part of these efforts.

During the reporting quarter, global comp sales grew 2.7%, helped in part by the continued popularity of its all-day breakfast and the introduction of new chicken nuggets, marking the Company’s 6th consecutive quarter of positive comp sales. However, McDonald’s reported a 1.3% decline in US same-store sales, which was offset by gains in International Lead segment, where comps increased 2.8% for the quarter. Comparable sales grew 4.7% in the High Growth segment, led by strong performance in China and positive results across the entire segment. In the Foundational markets, comparable sales rose 11.1% in Q4 FY16, led by very strong performance in Japan and certain markets in Latin America, as well as solid results across the segment’s remaining regions.

Over the past few months, McDonald’s has introduced all-day breakfasts, simplified its sprawling menus, and improved service to turn around its business amid intense competition from Burger King Worldwide Inc., the brand owned by Restaurant Brands International Inc. (NYSE: QSR), The Wendy’s Company (NASDAQ: WEN), Subway, Dunkin’ Brands Group Inc. (NASDAQ: DNKN), and nimbler upstart chains. Under CEO Steve Easterbrook, McDonald’s is working to change customer perceptions by switching to cage-free eggs and chicken free of certain antibiotics, as well as removing preservatives from menu items including Chicken McNuggets. McDonald’s has also changed its menu to include fresher ingredients and custom-made meals to bring back young customers who have turned to fast casual restaurants that serve gourmet, customizable burgers.

Consolidated operating income rose 5% (grew 7% in constant currencies). In all, McDonald’s net income fell 1% to $1.19 billion (grew 1% in constant currencies), or $1.44 per diluted share, compared to net income of $1.20 billion, or $1.31 per share, a year earlier, bearing the negative impact of the ongoing refranchising and G&A initiatives.

Full year FY16 financial highlights

During FY16, McDonald’s total revenue decreased 3% to $24.62 billion (flat in constant currencies), due to the impact of its refranchising efforts. Global comparable sales increased 3.8%, including positive comparable sales across all segments. Consolidated operating income increased 8% to $7.74 billion (11% in constant currencies). In all, McDonald’s net income grew 3% to $4.68 billion (grew 6% in constant currencies), or $5.44 per diluted share, compared to net income of $4.52 billion, or $4.80 per share, a year earlier, benefitting from higher gains on sales of the restaurant business, mostly in the US.

Segmental highlights

During Q4 FY16, McDonald’s same-restaurant sales in US restaurants fell 1.3%, reflecting the challenging comparison against the prior year launch of the very successful All-Day Breakfast. Operating income fell 11%, as the US lapped a prior year gain on the strategic sale of a restaurant property.

Comparable sales for the International Lead segment grew 2.8% during Q4 FY16, reflecting strong sales in the UK and positive results in Australia, Canada, and Germany. The segment’s operating income grew 1% (6% in constant currencies), fueled by sales-driven improvements in franchised margin dollars across most markets.

Comparable sales in the High Growth segment grew 4.7% during Q4 FY16, led by strong performance in China and positive results across the entire segment. The segment’s operating income rose 16% (18% in constant currencies), driven primarily by improved restaurant profitability in China, which benefited from the recent VAT reform.

Comparable sales in the Foundational Markets jumped 11.1% during Q4 FY16, led by very strong performance in Japan and certain markets in Latin America. For the segment, which includes Corporate SG&A and other costs, operating income increased for the quarter. These results primarily reflect a gain from the sale of McDonald’s Singapore in connection with the Company’s refranchising initiatives, as well as improved performance in Japan.

Other highlights

Restructuring initiatives: Under CEO Steve Easterbrook, McDonald’s is working to change customer perceptions by switching to cage-free eggs and chicken free of certain antibiotics, as well as removing preservatives from menu items including Chicken McNuggets. McDonald’s has also changed its menu to include fresher ingredients and custom-made meals to bring back young customers who have turned to fast casual restaurants that serve gourmet, customizable burgers.

McDonald’s is in the process of consolidating its restaurants to have fewer franchisees in the US. This forms part of McDonald’s massive corporate restructuring initiative announced in May 2015, aimed at reorganizing its struggling business. The restructuring effort is set to save the company $500 million by 2018. As part of this restructuring, only 10% of McDonald’s stores will be company-owned by 2018. Currently, 80% of its restaurants are franchisee-owned. McDonald’s is also selling about 3,500 of its 36,000 restaurants as part of these plans.

Sale of stake in China and Hong Kong operations: McDonald’s has agreed to sell a controlling stake in its China and Hong Kong business to state-backed conglomerate CITIC Ltd. and Carlyle Group LP (NASDAQ: CG) for up to $2.1 billion on January 09th, 2017. The move is part of McDonald’s massive corporate restructuring initiative to reorganize its struggling business and save the company $300 million annually.

Under the deal, Hong Kong-listed CITIC Ltd will own about 32% of the business, with CITIC Capital, an affiliate company that manages private equity funds and other alternative assets, holding another 20%. CITIC is a large Chinese conglomerate with interests in businesses ranging from energy and manufacturing to real estate. Carlyle will control 28% of the business, while McDonald’s will retain a 20% stake. The deal will be settled in cash and in shares in the new company that will act as the master franchisee for a 20-year period. McDonald’s China and Hong Kong business reported about $200 million in earnings before interest, depreciation, and amortization in FY15. McDonald’s currently has more than 2,400 restaurants in Mainland China and roughly 240 in Hong Kong.

Returns to shareholders: McDonald’s returned $2.2 billion to shareholders through share repurchases and dividends in Q4 FY16 and $14.2 billion for the full year FY16, marking the successful achievement of the Company’s targeted return of $30 billion for the three-year period ending 2016. In addition, McDonald’s announced a 6% rise in its dividend beginning Q4 FY16.

Guidance

In connection with executing against its refranchising and G&A targets, McDonald’s expects to incur additional strategic charges over the next two years. By 2018 and beyond, McDonald’s expects to refranchise about 4,000 restaurants with a long-term goal to become 95% franchised. The restructuring effort is set to save the company $500 million by 2018.

Stock Performance

McDonald’s stock stood at $121.05, slipping 0.27%, at the close on Tuesday, January 24th, 2017, having vacillated between an intraday high of $122.06 and a low of $120.52 during the session. The stock’s trading volume was at 3,488,688 for the day. The Company’s market cap was at $100.46 billion as of Tuesday’s close.

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