McDonald's: This Franchise King is Still Expanding
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I am still a big kid at heart. Whenever I feel a little homesick, I go looking for those familiar golden arches. Just stepping through the door my mind floods with happy memories of a carefree childhood. Opening that familiar cardboard box, seeing that sesame seed topped bun and sinking my teeth into my good friend the Big Mac brings a smile to my face.
I grew up with Ronald McDonald. I have traveled across South Korea, China, Thailand, Cambodia, Mexico, and Germany. In those moments when I crave the good old U.S.A., I start looking for the arches.
McDonald’s (NYSE: MCD) is the epitome of a fast food restaurant. The menu evolves often offering new innovative fresh ideas. When I was a kid and my parents went out for the night it meant a burger, fries and a soda for my brother and me. Today its oatmeal and McCafe drinks, fresh salads, fruit smoothies and Angus Snack wraps.
As the menu grows so does the stock price. Over the last five years, the stock has doubled. You may stop and ask, “Is it getting too expensive?” McDonald shareholders seem to “keep loving it”.
Is McDonald’s reaching the saturation point? At the end of 2011, the company owned 6,435 restaurants and 27,075 franchised locations. Euromonitor International compiles data on “Informal Eating Out (IEO) restaurant locations. McDonald’s annual report indicates it only has a 0.5% presence worldwide in the IEO industry. It would appear that there is tremendous room for growth to continue for a long time before McDonald’s needs to be concerned about saturation.
McDonald’s projects the opening of 900 new restaurants in 2012, a 2.68% rate of growth. While the bulk of stores are located in the U.S, the majority of the new restaurants (750) are expected to be in the Asia-Pacific region. This region is growing at a rate of 19%, which will affect sales growth as well. At this rate, the Asia-Pacific area is poised to equal U.S. market share within the next 3-7 years.
The franchise business model is the Golden Arches biggest advantage. Franchisees own more than 80% of the chain’s restaurants worldwide. As a result, there is a steady stream of free cash flow McDonald's can use to focus on growth. The franchise model is so successful that competitors are following suit.
Burger King plans to franchise nearly all of its 7,200 chains in the United States and more than 12,500 of its international stores by 2013. Yum! Brands (NYSE: YUM) is also getting on the bandwagon with only 13% of its U.S. restaurants owned by corporate. Jack in the Box has about 25% of its stores operated by a franchisee.
There are a few reasons why franchising is good for McDonald’s. Basically, it saves money and reduces operating expenses. The franchise model provides capital McDonald’s can use to continue growth. The franchisee invests his/her own money creating high motivation for success. Profitability creates more motivation that results in higher royalties for McDonald’s.
McDonald’s is still king in the franchising model. Its core business is rock solid and McDonald’s has learned how to flawlessly execute the strategy. The stock comes to the table with a P/E ratio of 18 and a 2.8% dividend yield, compared to Yum!’s pricy P/E of more than 25 and a dividend yield of just 1.6%
Both brands are expanding overseas. Yum! opened 656 new stores in China in 2011. McDonald’s still has more global potential. Emerging markets are the key to industry expansion and success.
In Europe, McDonald’s 1,500 McCafe locations compete directly with its competitors like Starbucks and Dunkin’ Brands. The McCafe line of beverage expansion is directly targeting the coffee and beverages market. There are over 2 billion cups of coffee consumed everyday in the world. This creates huge potential for growth.
In Asia-Pacific, McDonald’s is rolling out dessert kiosks. If they indicate a successful return McDonald’s will establish this model in other worldwide locations. Another unique feature in this region is food delivery. This is a successful model at over 1,500 restaurants. Many customers worldwide would jump on this kind of convenience. The model will change the way McDonald’s provides customer service just as drive-thru service did years ago.
McDonald’s is facing some management challenges. CEO, Jim Skinner, is retiring in July. Don Thompson, Chief Operating Officer, is stepping into the top management slot. Thompson joined the company in 1990. He has never served in an overseas position. With foreign operations so integral to McDonald’s long-term growth this will be an interesting transition to watch.
McDonald’s is not resting on its laurels of the king of fast foods. The stock is selling strong and expecting to grow by 10%. While growth was only 7.5% in the U.S., less than the 7.7% expected, growth in Asia, particularly China, gives McDonald’s a lot of room for global growth. Even in this tenuous market McDonald’s continues to deliver. It sells affordable meals offering convenience while still being accessible to consumers who may be cutting back on expenses in higher priced restaurants. McDonald’s has also been focusing on its beverage lineup to appeal to a more upscale market. Refreshing its image by remodeling many older locations across the U.S. has incited consumer interest.
Therefore, what is the risk versus reward? Take a look at the stock and trading history back to 1970. It has generated an annual compound rate return of 18.6%. That is a very solid return based on the S&P 500 return of 9.9% over the same time period.
McDonald’s appears to have many things going for it. Expansion and growth continue. The menu is expanding and evolving. New beverages are tantalizing the consumer’s pallet. Affordable dining-out costs meet the consumers desire to go out while still cutting overall expenditures for enjoying a meal out.
While burger and fries may not be not your cup of tea, McDonald’s may be the return on investment you have been hoping for.
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