McDonald's Sale Of Its China Market Said To Be Imminent, Beneficial To Margins

The potential sale of McDonald's Corporation MCD’s China market would likely result in a muted response to shares, according to a note from Wells Fargo analyst Jeff Farmer. However, the potential deal would boost margins significantly.

McDonald's To Go The Way Of Yum?

A Wall Street Journal report said a consortium, including private-equity giant Carlyle Group, is close to a deal valued at as much as $2 billion to buy McDonald’s China franchise. Recall that peer Yum! Brands, Inc. YUM is in the process of spinning off its China business.

“Although the China deal would represent the largest refranchising transaction in MCD history, the Latin America case study points to a modest reaction to a potential China announcement (MCD -0.9 percent vs. S&P 500 +0.9 percent on April 20. 2007),” Farmer wrote in a note.

That said, the multiples are expected to expand in out-quarters once the benefits of higher margins and return on invested capital (ROIC) kicks in.

Farmer estimates the potential China transaction could drive an 800 bps increase in EBITDA margin (from 40.4 percent to 48.4 percent) and 150 bps increase (from 16.7 percent to 18.2 percent) in ROIC as the revenue mix shifts to much higher margin and lower capital intensity franchise revenue.

Analyst's Moves

However, the analyst cut his 2017 EPS estimates to $6.20 from $6.40 to reflect forex and China deal timing.

Meanwhile, Farmer reiterated his Market Perform rating on McDonald’s given the “long-tail nature of valuation-expansion follow through and uncertainty around impact of potential corporate tax reform.”

The analyst, who has a valuation range of $121 to $126 on McDonald’s shares,  expects shares to be relatively range hound in the near term as it demonstrates an ability to held on to market share gains in key geographies.

At last check, shares of McDonald’s were down 0.32 percent to $122.45.