Don't Sell McDonald's Stock Because Of 2 Minimum Wage Myths

| About: McDonald's Corporation (MCD)


McDonald's investors often express worry about the effects of minimum wage increases on the company's business model.

The Truth About Myth #1: Only a third of McDonald's revenue comes from the United States.

The Truth About Myth #2: Only 19% of McDonald's stores are directly affected by minimum wage hikes due to franchising arrangements.

When the topic of raising the minimum wage and the business impact of mandatory wage increases on blue-chip stocks becomes a part of the national conversation, as it did during President Obama's State of the Union Address in January, the two companies that immediately come to people's minds are Wal-Mart (NYSE:WMT) and McDonald's (NYSE:MCD).

Today, I want to discuss why it is a flaw to make a buy or sell decision about McDonald's based on whether or not the United States raises the mandatory wage for food-service employees.

First of all, it's quickly becoming a quaint and erroneous notion to think of McDonald's as an American company whose business performance is solely determined by the political whims of the United States legislature. In 2013, McDonald's brought in $28.1 billion revenue. Across its global operations, only 31% came from the United States. In other words, $8.71 billion of the company's revenue comes from America, and $19.39 billion comes from the rest of the world.

A similar, although not quite as disproportionate story emerges when you look at the company's net earnings. Only 43% of earnings came from the U.S., and 57% came from the rest of the world. In 2013, McDonald's brought in $5.5 billion in profit for shareholders. Roughly, $2.36 billion came from the United States, and $3.14 billion came from the rest of the world. The other thing worth noting is this: for both sales and earnings figures, the numbers are moving directionally lower for the United States. In other words, every year, U.S. operations contribute a smaller and smaller percentage of the McDonald's profit pie.

In addition to the diminishing influence of the United States on McDonald's corporate balance sheet, there is another factor that is rarely discussed when analyzing McDonald's as an investment in the context of a minimum wage increase: the company largely operates on a franchisor/franchisee business model, and therefore, is able to avoid directly absorbing the financial costs associated with a minimum wage hike.

As of the end of 2013, McDonald's has 35,400 restaurants across the world. About 81% of them are run by independent franchisees of the company, and the other 19% are actually owned by McDonald's itself. Almost all analysis of the minimum wage in the context of McDonald's ignores this fact: McDonald's is generally a real estate company with a toll-booth model (that is, it makes its money by charging franchisees rent for the stores and receives a certain percentage of sales as part of a fee arrangement for getting to use the McDonald's brand) that functions independently from operating the business.

It is the folks who run the franchises that have to toggle the minimum wage increases by deciding whether they want to modify hours, slow wage growth for that restaurant's management, raise prices, or accept declining profits. But that's a dilemma that only has a direct impact on a small amount of McDonald's stores: only about 6,700 of the company's chains are actually run by McDonald's, making a minimum wage increase a small headwind for management to address as they try to increase the company's profits.

And, of course, McDonald's is decreasing the percentage of stores directly under its control over time. It has been actively franchising some of its company-owned locations over the past three years since coming out of the financial crisis, and the company is investing $3 billion this year to open 1,500 new stores. Directionally speaking, McDonald's is continuing to reduce the number of company-owned locations that are going to contribute to its overall earnings.

When discussions of McDonald's as an investment come up on Seeking Alpha, many investors and commenters seem to indicate that the future outlook of the minimum wage factors into their personal calculus of whether McDonald's ought to be an investment going forward. But when you study the actual corporate structure of McDonald's, you will see that the company heavily insulates itself from directly assuming the costs of minimum wage increases. Only about a third of the company's revenue comes from the U.S., and that figure is declining. Only one of five McDonald's stores are actually operated by McDonald's, and that figure is declining as well. For people concerned about the effect of minimum wage increases on McDonald's, it is a modest headwind. There are only 6,700 stores where the rise in minimum wage must be borne directly. For McDonald's' long-term shareholders, a minimum wage increase would be nothing more than a glorified rounding error in affecting the firm's profitability.

Disclosure: I am long MCD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.