McDonald’s reported pleasing results with 10% organic top-line growth in the quarter, beating analyst expectations yet again. This is a formidable achievement seeing the weak worldwide economic backdrop and a 6% headwind from the strong dollar, seeing more than 60% of its business is based outside the US. 
The share reacted favorably on the results, building further on its strong record of double-digit compounding returns, beating the challenging S&P 500 index over all of the past five, 10 and 20 year periods.
McDonald’s has a simple business model – it is in essence one of the world’s largest property owner (the restaurants), renting the restaurants out to franchisees who also pay royalties on their sales for using the brand and the McDonald’s system for sourcing ingredients, menu development, quality control, marketing & promotions, technological developments, etc. It is the ideal landlord/tenant relationship because one is very dependent on the other – it is in essence another form of a partnership.
The company has a relatively low cost base because the franchise owners cover their own restaurant operating expenses (including staff costs). McDonald’s is therefore less exposed to inflationary costs, enjoying a high gross margin of over 65% and return on invested capital of over 18%.
Of course, some franchisees are more successful than others, but seeing the McDonald’s business model, it is in the company’s best interest to provide further support when necessary with additional training and new technologies to increase their efficiency and performance.
Today vast numbers of McDonald’s restaurants are open 24/7 selling its famous Big Macs, McNuggets and Happy Meals mainly via Drive-Thru facilities and increasingly also with delivery partners such has GrubHub and UberEats, providing additional organic growth. They have recently completed a phase of joint investment with its franchisees to embrace new technology in its restaurants such as touch display ordering and weather responsive digital menu offerings.
Going forward they are now focused on increasing restaurant count, with 800 planned for China. We estimate this alone should add another 1.5% to the top line.
On the cost side, the group has over many decades invested heavily in its own supply chain, which helps to protect franchisees from the worst of the current food cost crisis. This enables them to continue generating demand through maintaining their high product quality standards and keeping its prices attractively low. This is an important competitive edge against most other restaurants, especially in more difficult times.
Many shareholders fear the new rising interest rate environment because of high gearing in their businesses while the economic outlook is weakening. Despite its strong cash flow, McDonald’s has also earlier taken on cheap debt to buy back vast amounts of shares. They have though, fixed almost all of their outstanding debt at lower rates, maintaining their investment grade rating. Rising interest rates may therefore have little direct effect on McDonald’s results, while shareholders benefit from the vast amounts of shares that have been cancelled from the buy-backs.
The quality of their raw materials is often underestimated – in fact, quality raw materials is a McDonald’s trait. They have also developed their menu with many healthy options, (now also the McPlant burger) and it is actively taking steps to improve animal welfare across its supply chain.
The McDonald’s dividend per share has grown at an attractive +7% p.a. over the past five years. With their unique business model, there is little reason to doubt that they have a better chance than many peers for continuous delivery during more difficult economic circumstances.
Gerrit Smit is manager of the Stonehage Fleming Global Best Ideas Equity fund and a holder of McDonald’s. The views expressed above should not be taken as investment advice.