The Long and Short
An appetite for McDonald’s as Russia-Ukraine widens spreads
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Of all credits in the investment grade universe, McDonald’s (Baa1/BBB+) has among the most revenue exposure to the Russia-Ukraine conflict. The two countries combined contributed approximately 9% of company revenues in fiscal 2021. The intermediate and back end of MCD’s curve has widened more than the consumer discretionary curve over the past month, but any impact from sanctions imposed is not likely to materially affect credit metrics or margins. If all EBITDA from both countries disappeared completely for a full year, leverage would increase less than one tick. Any widening associated with the conflict makes MCD a better relative value.
Exhibit 1. MCD Curve vs. Consumer Discretionary Curve (Now vs. 1 Month Ago)
Source: Bloomberg TRACE; APS
MCD has seen a strong rebound since the pandemic started, having posted systemwide sales growth of 21% in 2021. That growth was largely fueled by the U.S. market, which posted comparable sales growth of 13.8% for the year, marking the highest U.S. annual comparable sales percentage ever reported.
Exhibit 2. MCD Systemwide Restaurants (FYE 2021)
Source: Company Supplemental Reports; APS
Russia/Ukraine a Small Percentage of Overall System
MCD ended the most recent fiscal year with a systemwide restaurant count of 40,031 as seen in Exhibit 2. The combined Russia/Ukraine restaurant count represents 2.4% of MCD’s total restaurants. According to MCD, 84% of Russian restaurants and all of the Ukraine restaurants are company operated. That said, on a combined basis Russia and Ukraine accounted for 9% of revenues in 2021, but only 2% of systemwide sales. On an operating income basis, the combined countries only accounted for less than 3% of operating income, as franchised restaurants carry higher operating margins.
Given the sanctions being imposed, if one were to assume a full loss of revenues and operating income from the combined countries, we note that would have less of an impact than the revenue and operating income loss caused by the pandemic in 2020 for MCD. Furthermore, a loss of 3% of EBITDA would only increase MCD’s non lease-adjusted leverage metric from 2.98x to 3.07x. We think there is little to no risk to ratings from its exposure to both countries, and believe the strong rebound being witnessed in the United States could help to offset any lost revenues and income.
Strong Free Cash Flow Further Underscores Positive View
Not only did MCD witness its strongest annual comparable sales growth this year, but free cash flow also hit an all-time high. MCD posted free cash flow of $7.1 billion for fiscal 2021, up nearly 54% from the year-ago period and 25% from 2019. We note that FCF/sales for the year was a strong 30.6%, up 650 bp year-over-year and 380 bp from 2019. Management noted that franchisee cash flows hit all-time highs in most of their top markets, including the U.S., U.K., Canada, Germany and Japan. In the U.S., management noted that cash flow per store increased $125,000, which puts MCD at $500,000 in cash flow per unit. This helps to put franchisees in a stronger position to weather inflationary pressure which was up 4% in 2021. Capital allocation priorities remain unchanged with MCD looking to invest in new units and update existing restaurants to fuel growth, with the dividend and share repurchases remaining second and third priorities, respectively.
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