CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) of McDonald's Corporation (NYSE: MCD) at 'BBB+/F2'. The Rating Outlook has been revised to Negative from Stable. At Sept. 30, 2015, McDonald's had approximately $18 billion of total debt.
A full list of ratings is provided at the end of this release.
KEY RATING DRIVERS
Aggressive Financial Strategy
The Negative Outlook reflects McDonald's aggressive financial strategy during a period of challenged operating performance as the sustainability of recent same-store sales (SSS) performance remains uncertain.
McDonald's cash flow priorities have consistently been to invest in its business and return all remaining cash flow to shareholders. However, management is demonstrating a growing willingness to utilize its balance sheet to increase shareholder returns. Fitch views this as a change in financial strategy and projects that total adjusted debt/EBITDAR will approximate the mid-3x range in 2016, up from 3.1x at Sept. 30, 2015 and 2.6x at Dec. 31, 2014.
Absent sustained improvement in SSS and meaningful progress with refranchising and cost savings, total adjusted debt/EBITDAR could be sustained at or exceed the mid-3.0x range beyond 2016, resulting in a downgrade in ratings. Maintaining the current level of share buybacks beyond 2016 could also contribute to a negative rating action.
McDonald's intends to return about $30 billion of cash to shareholders via dividends and share repurchases during the three-year period ending 2016, with $7 billion returned through the third quarter of 2015. The plan is $10 billion higher than the company's previously articulated target with the vast majority financed with additional debt. McDonald's already issued $4.2 billion earlier this year to help accelerate share buybacks in 2015. Fitch assumes McDonald's could issue an incremental $8 billion of debt within the next 12 months to meet its new target.
Fitch currently assumes that McDonald's comps will stay in the low-single-digit territory in 2016 and 2017 and EBITDA remains fairly stable to 2015 projected levels of $9.1 billion. Fitch's longer-term forecast incorporates a cumulative $2 billion of cash proceeds from the sale of company units, gradual realization of $500 million of G&A expense savings, and that refranchising has only a modest negative impact on operating income.
Sustainability of Recent SSS Performance Is Uncertain
During the quarter ended Sept. 30, 2015, global SSS increased 4.0% with all segments contributing. Comparable sales increased 0.9% in the U.S., 4.6% across International Lead markets, 8.9% in High Growth markets, and 6.1% in Foundational markets.
However, McDonald's is in the early stages of its turnaround plan. The brand continues to lose market share, particularly in the U.S. where McDonald's reported a 3.2% comp gap to the quick-service sandwich category during the September quarter. Global comparable guest counts are down 3.1% and 3.7% for the nine- months ended September 2015 and September 2014, respectively.
Fitch views a cohesive and aggressive system-wide effort to improve service, emphasize food quality and provide locally-relevant menu variety as necessary catalysts for sustained SSS growth.
New Refranchising Target
McDonald's intends to increase the percentage of its global system that is franchised to 93% by the end of 2018 from 81% currently by selling 4,000 units to operators. Longer term McDonald's strives to become 95% franchised. Refranchising will mainly occur in McDonald's High Growth and Foundational market segments which are currently 44% and 90% franchised, respectively. High Growth markets include China, Italy, Poland, Russia, South Korea, Spain, Switzerland, and the Netherlands. Foundational markets include various countries outside of the U.S. and International Lead markets (Australia, Canada, France, Germany, and the U.K.).
Fitch views McDonald's decision to reduce the number of company-operated restaurants as consistent with industry trends. Franchising increases the stability and quality of cash flows, given that it produces a steady stream of royalty and rental income and has low capital requirements. Fitch anticipates that capital expenditures will decline meaningfully from approximately $2 billion expected for both 2015 and 2016, if the company successfully meets its goal.
Increased Cost Reductions
McDonald's also raised its annualized year-end 2017 G&A cost reduction target to $500 million from $300 million. The goal represents nearly 20% of McDonald's $2.6 billion expense base at the beginning of 2015. Savings will be realized through refranchising, lower corporate overhead, and greater efficiencies across global business services.
McDonald's expects to realize $150 million of savings by the end of 2016. Fitch anticipates savings to accelerate with the pace of refranchising and, along with incremental royalty and rental-based income, to help offset operating income declines associated with the sale of company-operated restaurants.
--Positive low-single-digit SSS growth of about 2% in 2016 and beyond;
--Operating income grows 5%-7% in 2016 and declines slightly thereafter due to refranchising;
--Total debt increases to, and is sustained at, about $26 billion;
--Free cash flow (FCF) approximates $1.5 billion in 2016;
--Total adjusted debt-to-operating EBITDAR (defined as total debt plus 8x gross rents-to-operating EBITDA plus gross rents) in the mid-3.0x range in 2016.
Future developments that may, individually or collectively, lead to a negative rating action include:
--Weak SSS performance in 2016 and continued market share losses;
--The lack of meaningful progress with refranchising and realization of cost savings;
--Total adjusted debt-to-operating EBITDAR sustained in the mid-3.0x range due to weaker than expected operating results and share buybacks staying elevated in 2017.
Future developments that may, individually or collectively, lead to a Stable Outlook include:
--Several quarters of sustained positive low-single-digit SSS growth and stabilization of market share;
--Meaningful progress with refranchising and realization of cost savings;
--Total adjusted debt-to-operating EBITDAR sustained in the low-3.0x range.
McDonald's liquidity is supported by its large cash balance, FCF (cash from operations less capex and dividends), and an undrawn revolving credit facility that expires December 2019. At Sept. 30, 2015, McDonald's had $5 billion of liquidity consisting of $2.5 billion of cash and $2.5 billion revolver availability. FCF typically exceeds $1 billion annually and was $1.5 billion for the nine months ended September 30.
Upcoming debt maturities include approximately $800 million in 2016 and about $1 billion in 2017. Fitch expects near-term debt maturities to be refinanced given McDonald's shareholder-friendly activities.
Fitch affirmed the ratings for McDonald's as follows:
--Long-term IDR at 'BBB+';
--Bank credit facilities at 'BBB+';
--Senior unsecured debt at 'BBB+';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
The Rating Outlook has been revised to Negative from Stable.
Additional information is available on www.fitchratings.com.
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
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