McDonald’s Looks to Flip Its Stores for Growth

June 2, 2014 by 247sarah

McDonald's 1990's logoWall Street gave McDonald’s (NYSE: MCD) plan to return as much as $20 billion to shareholders over the next three years a collective shrug. The combination of dividend payments, share buybacks, and refranchising opportunities may be above the level it’s used over the past few years, but when compared to what it’s done over longer periods of times, it’s nothing extraordinary and that might not be enough to move the needle.

McDonald’s announced during the Sanford C. Bernstein Strategic Decisions Conference the other day that between now and 2016, the burger joint would return a total of $18 billion to $20 billion to shareholders, a 10% to 20% increase compared to its actions over the three-year period between 2011 and 2013. It noted a good portion of its intended use of the cash proceeds would come from adding to its debt levels as well as refranchising at least 1,500 restaurants.

Refranchising is the process of selling company-owned stores back to franchisees, a trend we’ve been witnessing more of lately. DineEquity (NYSE: DIN) is arguably the biggest practitioner of refranchising in recent years. After acquiring the Applebee’s chain in 2007, DineEquity has made it an almost wholly franchised operation within the company, and it’s rolling over its IHOP pancake houses, too. And others are following suit. Yum! Brands (NYSE: YUM) refranchised all of its U.K.-based Pizza Hut restaurants and is steadfastly refranchising its Taco Bell stores in the U.S. Wendy’s (NASDAQ: WEN) began refranchising 425 stores last summer and Burger King (NYSE: BKW) was flipping hundreds of stores to its franchisees for over a year.

While the process initially causes the restaurateur to take a hit to revenues, because refranchising usually reduces the parent company’s overhead while providing it a generally stable stream of income it helps to raise profit margins. But it’s a delicate balance because you still need strong restaurant operators so they’re not serving as a drag on overall performance.

It’s usually seen as a bullish indicator, for the economy at least, if not the restaurant itself, since it indicates there is financing available to underwrite the purchase. The industry, though, is in a state of flux at the moment, and nowhere is that more evident than in the burger chains, particularly in their breakfast dayparts.

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McDonald’s is getting waffled by both Taco Bell and White Castle, which see breakfast as a lucrative ticket to quick profits, and want to siphon off sales from the industry leader. The burger king has a 31% market share in the daypart and while the impact of those two chains will likely be minimal — Wendy’s once made a stab at it and had to give up — it shows the environment might not be all that conducive to franchisees shouldering more of the burden.

McDonald’s says the planned increase in the pace of refranchising is higher than 50% when compared with the level of activity over the past three years, but analysts note it’s actually on par with the pace it kept between 2007 and 2009 when it also refranchised 1,500 units. Moreover, since the restaurant chain is already more than 80% franchised, results won’t be nearly as dramatic as they would be had it been starting from a much lower base. And since it plans on spending some $3 billion of  this to add 1,100 stores to its global footprint, while the refranchising will occur over a three-year period, the effect will be to dilute whatever gains it might have made from the effort.

Investors gave a boost to McDonald’s shares after it revealed its plans for the future. I’m just not sure that Wall Street hasn’t gotten it right this time after all.

 

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