McDonald’s Corporation

Moat: 3/5

Understandability: 1/5

Balance Sheet Health: 4/5

McDonald’s Corporation operates as a global franchisor of restaurants, relying heavily on a network of independently owned or licensed establishments across the globe.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

McDonald’s business model centers around franchising, where the company licenses its brand, operating systems, and menu to independent operators. While it operates restaurants directly, franchising accounts for most of its revenue.

Notably, approximately 95% of McDonald’s restaurants globally are owned and operated by independent franchisees.

  • Revenue Streams:
    • Franchised Restaurants: This segment encompasses fees and rents from franchisees.
    • Company-Operated Restaurants: This segment includes revenue from restaurants operated directly by McDonald’s, representing a smaller portion of revenue.
  • Global Reach: McDonald’s operates in over 100 countries and territories, making it a truly global brand with significant international exposure.

For the year ended 2022 the Company recorded revenues from international operated restaurants of $8.9B compared to just $5.9 B from company owned restaurants.

  • Brand Recognition: McDonald’s holds a strong global brand that is well recognized all over the world. It has been a brand that is known by people of all ages and from a lot of places.

McDonalds is recognized as the “most valuable brand”, by interbrand in their annual report.

  • Menu Diversity: The company offers a menu of globally recognized items, while also tailoring its menu to each country’s specific taste, reflecting changing customer preferences.
  • Technology Integration: The Company relies on technology-driven solutions, such as mobile ordering and digital menu boards, to enhance their customer experience.
  • Franchising Model: The reliance on franchisees as opposed to company-operated restaurants helps the company in growth.
  • Continuous Evolution: The company has a long history of adapting to change over time.

Moat Analysis

McDonald’s moat can be considered narrow, as it displays some, but not all of the characteristics associated with strong competitive advantages:

  • Brand Recognition: McDonald’s has a well-known brand, which makes it a popular choice for customers. However, brand recognition isn’t enough as the company faces strong competition from other restaurants.

While McDonald’s brand name is strong, it does not confer as great a pricing advantage as say, Tiffany for example.

  • Switching Costs: The costs of switching to another fast food chain are quite low, since all serve pretty similar menus and don’t have high costs associated with switching brands. So there is minimal lock-in.
  • Network Effects: There are few network effects, since one more customer at a certain McDonald’s isn’t likely to influence others to go there as well.
  • Economies of Scale: Scale is a more compelling advantage for the company because it has numerous outlets spread across the globe, which also helps them in negotiations for materials. While other restaurants could try to replicate the same, it would be difficult for them to do so in a sustainable manner.
  • Regulatory Approval: Although not required, they have certain levels of standards to be followed and regulations, and their brand has passed this tests.

Moat Rating: 3/5: McDonald’s has a brand, large reach, and strong bargaining power, but its moat isn’t strong enough to prevent competition from other similar restaurants. This means that they are able to produce above-average returns on capital in the long run but are not guaranteed.

Business Understandability

Understandability Rating: 1/5 McDonald’s business model is easy to understand. It sells food using a franchise model to millions of people. You don’t have to be an economist to understand that. It has strong brand recognition, many restaurants, and sells a low-cost commodity product (food), that is consumed by a large number of people regularly.

Balance Sheet Health

Balance Sheet Health Rating: 4/5 McDonald’s has a reasonably healthy balance sheet, but some concerns remain regarding debt levels:

  • Assets: McDonald’s has high levels of cash and cash equivalents. The company also has a lot of leased properties. They also have good inventory levels, and net property, plant, and equipment.
  • Liabilities: The long term debt is considerable and may cause problems in the future, however, it is currently easily manageable.
  • Equity: The equity seems to have had some struggles over the past couple years, but now is on the rebound.
  • Overall: The company’s financial position is healthy.

Legitimate Risks

McDonald’s faces a few risks that could reduce their moat and business performance. They are:

  1. Changing Consumer Preferences: As consumers are more and more health-conscious, their demand for food from McDonalds may shrink, reducing their profits.

This has also been shown by a slight decline in the amount of same store sales for the last year.

  1. Increased Competition: New entrants into the fast-food market may pose a threat to McDonald’s position, while existing players could also try to improve their offers or menu.
  2. Economic Downturns: In economic recessions or hardships, consumers may start to eat out less, or might prefer going to even cheaper options, which could materially hurt their profits.
  3. Rising Costs: Increasing operating costs, especially from ingredients, as well as wage inflation may reduce margins.
  4. Regulatory Issues: Stringent regulatory restrictions, particularly in relation to nutritional information, may have an impact on the company.
  5. Ethical and Legal Issues: Any further issues that negatively impacts their business conduct might have a profound impact on their sales and profitability.

The company has previously experienced issues related to worker conditions and treatment, and must take care to not have any more of such events.

Management’s Outlook

The management recognizes these risks and is trying to mitigate them as much as possible by introducing various strategies:

The management is investing in technology, to provide ease of ordering and efficiency, and it is revamping restaurants to enhance the user experience.

  • The company is working on reducing its operational expenses, trying to implement a more cost-effective model.
  • McDonald’s also wants to use its brand recognition to capture customers, offering value and convenience.
  • They are investing heavily in digital and technology to improve the customer experience in its restaurants, and make things more efficient.

The management also mentions they are actively working on getting its “core menu” (burgers, fries, etc.) right and delivering higher quality in these products.

“We are seeing the impact of our efforts to strengthen our core menu, including our improved Quarter Pounder, and our expanded McRib, in particular.”

The CEO also wants to focus more on the “customer experience” and wants to make sure the customers enjoy and have good experiences at the store.

Recent Reports In the latest earnings call, McDonalds emphasized their value menu, and how much sales have been growing because of that. This is because customers, being under a heavy inflationary environment, may be more price sensitive, leading to them choose cheaper options. The company also mentioned how they are seeing higher success with “marketing and digital”, as well as their “drive-through business”, which still remains very popular.

Concerns The company faces a great number of hurdles to overcome in the next couple years with a lot of competition, changing consumer preferences, new regulations, etc. The company should be watched closely to make sure that it addresses those concerns effectively. In the latest earnings call, the company has mentioned a slowdown in the growth rate of their business in some countries, including France. It will be essential for them to reverse this trend if they are to meet their future revenue growth forecasts.

In the latest earnings call, while they expressed optimism, they did warn about the high interest rates environment and how that may make it more difficult for franchisees to raise money for expanding their stores.

In conclusion, McDonald’s is a global, stable, and easy-to-understand company, but with a narrow moat, reasonably healthy finances, and a good business model. It also has many issues it will have to overcome in the near future, making the investment a bit riskier.