Business context and reporting period
McDonald’s Corporation filed this Form 10-K for the fiscal year ended December 31, 2016. The company franchises and operates restaurants in 120 countries. At year-end, it had 36,899 restaurants, approximately 85% franchised, and a long-term goal of approximately 95% franchised. The filing also reports unaudited fourth-quarter results.
Financial performance and position
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Total revenue | $24.62 billion | $25.41 billion | Down 3%; flat in constant currencies |
| Operating income | $7.74 billion | $7.15 billion | Up 8%; up 11% in constant currencies |
| Operating margin | 31.5% | 28.1% | Up 3.4 percentage points |
| Net income | $4.69 billion | $4.53 billion | Up 3% |
| Diluted EPS | $5.44 | $4.80 | Up 13%; up 16% in constant currencies |
| Cash from operations | $6.06 billion | $6.54 billion | Down 7% |
| Capital expenditures | $1.82 billion | $1.81 billion | Approximately flat |
| Free cash flow | $4.2 billion | $4.7 billion | Down |
Global comparable sales rose 3.8%, while comparable guest counts fell 0.3%. Systemwide sales increased 3% (5% in constant currencies). Revenue declined mainly because refranchising replaced company-operated sales with lower reported franchise fees, partly offset by comparable-sales growth. EPS growth also benefited from share repurchases: the company repurchased 92.3 million shares for $11.1 billion in 2016.
At year-end, total debt was $26.0 billion, up from $24.1 billion; cash and equivalents were $1.22 billion, down from $7.69 billion. Shareholders’ equity was a deficit of $2.20 billion, compared with positive equity of $7.09 billion in 2015, reflecting substantial share repurchases and other equity movements. The company reported access to a $2.5 billion committed credit line, which was unused, and ongoing access to commercial paper markets. Its long-term debt ratings were BBB+ from S&P and Baa1 from Moody’s, both with stable outlooks.
For unaudited Q4 2016, revenue was $6.03 billion versus $6.34 billion in Q4 2015; operating income was $1.97 billion versus $1.88 billion; net income was $1.19 billion versus $1.21 billion; and diluted EPS was $1.44 versus $1.31.
Material changes and unusual items
- The company continued its turnaround, refranchising and restructuring initiatives. Company-operated restaurants fell to 5,669 from 6,444, while franchised restaurants rose to 31,230 from 30,081.
- Operating results included $342 million of impairment and other charges in 2016, with a reported $0.28 negative impact on diluted EPS. Gains on restaurant-business sales were $283 million, compared with $146 million in 2015.
- Interest expense increased 39% to $885 million, primarily due to higher average debt balances. The effective tax rate was 31.7%, compared with 30.9%.
- Cash returned to shareholders totaled $14.2 billion in 2016, including $11.1 billion of share repurchases and $3.1 billion of dividends. The quarterly dividend increased to $0.94.
- The company’s China and Hong Kong businesses, comprising over 2,600 restaurants, were classified as held for sale. The planned sale to a developmental licensee would leave McDonald’s with a 20% ownership interest; estimated proceeds were about $1.5 billion and the company expected a gain of $700–$900 million, subject to closing conditions.
Outlook, risks and contingencies
For 2017, management expected net restaurant additions to contribute about 1 percentage point to Systemwide sales growth in constant currencies; U.S. and International Lead commodity-basket costs to rise about 0.5–1.5% and 2.0%, respectively; SG&A to decline about 7–8% in constant currencies; interest expense to rise about 5–10%; capital expenditures of approximately $1.7 billion; and an effective tax rate of 31–33%. Long-term average annual targets beginning in 2019 include Systemwide sales growth of 3–5%, operating margin in the mid-40% range, high-single-digit EPS growth and ROIIC in the mid-20% range. Management also targeted $22–$24 billion of shareholder returns for 2017–2019.
Management’s strategy emphasized guest-count growth, restaurant modernization and technology, digital ordering and payment, and expansion of delivery pilots. Key risks include intense competition and changing consumer preferences; execution and return risks from refranchising, cost reductions and customer-experience investments; dependence on franchisee performance; commodity, labor and supply-chain costs; food safety and brand reputation; currency movements; regulation and litigation; cybersecurity; and tax uncertainty. The company disclosed pending litigation across its business but did not expect current matters to materially affect financial condition or results, while acknowledging that unfavorable rulings could adversely affect income. Gross unrecognized tax benefits were $924 million; transfer-pricing and other tax audits remain subject to resolution.
Important facts for investors to verify
- Whether comparable-sales gains translate into sustained guest-count growth, particularly in the U.S., where comparable guest counts declined 2.1% in 2016.
- Execution and financial effects of the refranchising plan, including the planned China/Hong Kong transaction and expected gain and proceeds.
- Whether projected cost savings, margin targets, modernization spending and digital/delivery initiatives achieve expected returns.
- Debt, refinancing needs, interest costs and shareholder distributions relative to operating cash flow; cash from operations and free cash flow declined in 2016.
- Developments in tax audits, the Luxembourg state-aid investigation, and the company’s substantial unremitted foreign earnings.