Fitch Affirms McDonald's IDRs at 'A/F1'; Outlook Stable
Fitch Ratings has affirmed the ratings of McDonald's Corporation (NYSE: MCD) as follows:
--Long-term Issuer Default Rating (IDR) at 'A';
--Bank credit facilities at 'A';
--Senior unsecured debt at 'A';
--Short-term IDR at 'F1';
--Commercial paper at 'F1'.
The Rating Outlook is Stable. At June 30, 2012, McDonald's had $13.6 billion of total debt. Roughly 68% of this debt was U.S. denominated and 32% was foreign denominated.
McDonald's ratings reflect its substantial cash flow generation, considerable financial flexibility, and leading global market position with nearly 34,000 units and over $85 billion of systemwide sales. Cash flow from operations has grown at a 10% compound annual rate since 2003 to $7.2 billion in 2011 and free cash flow (FCF) has averaged $1.6 billion during the same period. Furthermore, McDonald's cash balance has averaged over $2 billion since 2003, the firm has extensive access to public debt capital, and has an undrawn $1.5 billion revolver expiring November 2016.
Fitch expects operating cash flow to remain strong at approximately $7 billion in both 2012 and 2013, despite an increasingly challenged global economic environment and the prospect of higher commodity food costs in 2013. Reinvesting in its business and returning cash to shareholders while maintaining leverage appropriate for its 'A' credit rating are the foundation of McDonald's financial strategy.
McDonald's business model, which is based on a well-established franchisee network and significant real estate ownership, provides the firm a unique competitive advantage and strengthens its credit profile. At June 30, 2012, franchisees and affiliates operated 81% of McDonald's 33,735 units while the remaining 19% were company-operated.
Revenue from franchise operations, which consists of a stable stream of sales-based royalties and contractual rent payments, represented 32% of McDonald's $27 billion of total revenue in 2011. McDonald's owns about 45% of the land and 70% of the buildings for its system of restaurants. Net property and equipment had a book value of $23.1 billion at June 30, 2012.
McDonald's credit measures are appropriate for its 'A/F1' ratings and in line with Fitch's expectations. For the latest 12 month (LTM) period ended June 30, 2012, total debt-to-operating EBITDA and operating EBITDA-to-gross interest expense were 1.4 times (x) and 19.0x, respectively. Rent adjusted leverage, defined as total debt plus eight times gross rent expense divided by EBITDA plus gross rents (EBITDAR), was 2.3x. Rent adjusted interest coverage, defined as EBITDAR divided by gross interest expense plus gross rent, was 5.2x and funds from operations (FFO) fixed charge coverage was 4.3x. Fitch expects credit statistics to remain near these levels for 2012 and 2013.
Liquidity, Covenants and Maturities:
McDonald's consistently maintains abundant liquidity. At June 30, 2012, the firm had $4 billion of liquidity consisting of $2.5 billion of cash and, as mentioned earlier, an undrawn $1.5 billion revolver expiring in November 2016. The bank agreement does not contain financial maintenance covenants and none of its debt issuances contain change of control provisions. As of June 30, 2012, upcoming maturities of long-term debt totaled approximately $600 million in 2012, $1 billion in 2013, and $700 million in 2014. McDonald's has already prefunded some of these maturities as the firm had $1.2 billion of net debt issuances during the first six months of 2012.
Operating Strategy and Recent Performance:
McDonald's three global priorities are to optimize its menu, modernize the customer experience, and broaden accessibility to its brand. The firm is implementing this strategy with expanded beverage and breakfast offerings, re-imaging of restaurants, and a focus on value and branded affordability. Examples include new limited time offers such as a Chocolate Chip Frappe' and Apple Cinnamon Walnut Oatmeal in the U.S., the remodeling of 2,400 locations worldwide during 2012, and value platforms such as its Loose Change Menu in Australia and McDeal offering in Germany.
McDonald's long-term constant currency sales and operating income growth targets are 3% - 4% and 6% - 7%, respectively. Growing economic weakness in Europe, relentless competition in the U.S., slowing GDP growth in Asia, and mounting commodity cost pressures are expected to challenge these objectives in the near term. McDonald's global exposure is vast with 40%, 32%, and 22% of its revenue from Europe, the U.S. and APMEA (Asia/Pacific, Middle East, and Africa) in 2011. The remaining 6% was from other regions including Latin America and Canada.
McDonald's guidance of 3.5% - 4.5% food cost inflation in the U.S. and 2.5% - 3.5% in Europe during 2012 does not reflect the negative effects of the recent drought in the U.S. Commodity cost pressures, especially for beef and chicken, could intensify in 2013 and will only be partially offset with pricing.
McDonald's has repeatedly proven its ability to operate in difficult environments. Annual global same-store sales (SSS) have only declined twice in the past 16 years, despite multiple economic recessions. Consistent quality food at a good value, healthier menu options, convenience, and an extensive procurement and logistics infrastructure should benefit McDonald's in an increasingly challenged global restaurant industry environment.
For the six months ended June 30, 2012, McDonald's reported a 3% increase in both revenue and operating income to $13.5 billion and $4.1 billion, respectively. Excluding the negative effect of currency translation, revenue growth was 7% and operating income growth was 6%. Top line growth was driven by a 5.4% increase in global SSS, with every region of the world contributing, while operating income benefited from higher franchise profits.
McDonald's global franchise margin expanded 30 basis points (bps) to 82.8% while higher food and paper expenses caused its global company-operated margin to contract 50 bps to 17.9%. The company's combined operating margin declined 20 bps to 30.6%.
What Could Trigger A Rating Action?
Future developments that may, individually or collectively, lead to a positive rating action include:
--Sustainably strong operating performance, as exhibited by positive SSS growth and operating income growth, concurrent with a more conservative stance towards share repurchases and dividends would be a credit positive.
--A material reduction in leverage due to items mentioned above and continued generation of sizable FCF could result in an upgrade to McDonald's ratings.
Future developments that may, individually or collectively, lead to a negative rating action include:
--A downgrade in the near-to-intermediate term is not anticipated as McDonald's has modest room within its ratings.
--However, a prolonged period of SSS declines or margin contraction without a corresponding pull back in share repurchases and dividend increases could result in a negative rating action.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'2012 Outlook: U.S. Restaurants; Credit Risk Is Chiefly Contained as Sales Will Grow but Food Costs Remain Elevated' (Dec. 7, 2011).
Applicable Criteria and Related Research:
Corporate Rating Methodology
2012 Outlook: U.S. Restaurants
Carla Norfleet Taylor, CFA, +1-312-368-3195
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Judi M. Rossetti, CFA, CPA, +1-312-368-2077
Michael L. Weaver, +1-312-368-3156
Brian Bertsch, +1-212-908-0549