MCDONALDS CORP annual report, FY2019

Business context and reporting period

McDonald’s Corporation’s Form 10-K covers the fiscal year ended December 31, 2019; the filing also reports unaudited fourth-quarter results. The company franchises and operates restaurants in 119 countries. At year-end, 36,059 of 38,695 restaurants (93%) were franchised, making rent and royalty income the larger revenue source.

Financial performance and position

Unless stated otherwise, amounts are U.S. dollars. Full-year results:

Global comparable sales rose 5.9% and comparable guest counts rose 1.0%. U.S. comparable sales increased 5.0%, despite a 1.9% decline in guest counts; international operated markets recorded +6.1% sales and +3.5% guest counts. The 2019 effective tax rate was 24.9%, including an $84 million tax benefit; excluding it, the rate was 25.9%.

In Q4 2019, revenue was $5.35B versus $5.16B a year earlier; operating income was $2.29B versus $2.00B, net income $1.57B versus $1.42B, and diluted EPS $2.08 versus $1.82.

Liquidity, capital and balance sheet

Current assets were $3.56B and current liabilities $3.62B at year-end; cash was $0.90B. The company cited operating cash generation, commercial paper access and a $3.5B committed credit line (unused at year-end) as funding sources. Shareholders’ equity was negative $8.21B, compared with negative $6.26B in 2018. Debt equaled 131% of total capitalization under the company’s stated measure. These figures should be considered alongside the company’s substantial franchise-related rent inflows and lease obligations.

Total assets rose 45% to $47.51B, primarily because adoption of ASC 842 added lease right-of-use assets. Year-end lease right-of-use assets were $13.26B and lease liabilities totaled $13.38B. Debt was 92% fixed-rate; weighted-average debt interest rate was 3.2%. The company returned $8.56B to shareholders in 2019 through $4.98B of repurchases and $3.58B of dividends; annual dividends declared were $4.73 per share.

Material changes versus prior comparable period

• Franchised revenue increased 6% to $11.66B while Company-operated restaurant sales declined 6% to $9.42B, reflecting refranchising as well as sales trends. Franchised restaurants reached 93% of the system.
• Constant-currency sales growth and stronger franchised margins supported operating income; reported revenue was nearly unchanged because of currency translation and refranchising effects.
• Interest expense rose 14% to $1.12B, mainly due to higher average debt balances.
• Operating cash flow increased $1.16B. Investing cash use rose to $3.07B, including spending on acquisitions such as Dynamic Yield and Apprente.
• ASC 842 lease accounting materially increased reported assets and liabilities but was non-cash on adoption and had minimal initial income-statement impact.

Outlook, commentary and risks

For 2020, management expected net restaurant additions to contribute about 1.5 percentage points to Systemwide sales growth in constant currencies; SG&A to rise 5%–7%; interest expense to rise 4%–6%; an effective tax rate of 23%–25%; and capital expenditures of approximately $2.4B. The company planned roughly 1,400 openings and about 1,000 net additions. Long-term average annual targets were 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 emphasized the Velocity Growth Plan, restaurant modernization (Experience of the Future), digital ordering and personalization, and delivery. Delivery was available at nearly 25,000 restaurants and generated more than $4B in Systemwide sales in 2019. The company planned continued U.S. modernization, including about 1,800 projects in 2020.

Risks include execution and returns on modernization and technology investments; changing consumer preferences and intense competition; franchisee financial health and alignment; labor, commodity and supply-chain costs; food safety and brand reputation; cybersecurity and privacy; foreign exchange and international conditions; regulatory, litigation and tax uncertainty; and climate and environmental pressures. The company reported $1.44B of gross unrecognized tax benefits and expected possible resolution of significant IRS transfer-pricing matters in 2020; outcomes remain uncertain. It stated that pending litigation was not expected to materially affect results, while noting adverse rulings could have a material period impact.

A significant subsequent event was the coronavirus outbreak in China, which disrupted restaurant operations beginning in January 2020. The company expected a negative effect but could not reasonably estimate the financial impact. China represented approximately 5% of Systemwide sales, 1% of consolidated revenue and 3% of operating income in 2019. The filing also notes CEO Christopher Kempczinski’s appointment effective November 2019. The auditor issued unqualified opinions on the financial statements and internal controls; unrecognized tax benefits were identified as a critical audit matter.

Key facts for investors to verify

• Whether comparable sales growth can translate into sustained guest-count growth, particularly in the U.S., where 2019 guest counts declined.
• Whether modernization, digital, delivery and acquisitions generate returns commensurate with their investment and operating costs.
• Debt, lease commitments, refinancing needs and the sustainability of shareholder distributions; management planned to refinance $2.4B of maturing corporate debt in 2020.
• The duration and financial effect of the China coronavirus disruption, which could not be estimated in the filing.
• Resolution of IRS transfer-pricing matters and other tax exposures, including the $1.44B gross unrecognized tax-benefit balance.
• How reported trends compare on a constant-currency basis and after strategic charges, tax items and refranchising effects; these are management-adjusted views, not GAAP measures.