McDonald’s (NYSE:MCD), the leading global food-service retailer, has achieved dramatic growth using the franchise business model. We estimate that franchised stores currently contribute around 92% of McDonald’s stock value. The remaining 8% comes from company-owned stores.
Below we explain in detail why we expect company-owned stores to contribute relatively little to the value of McDonald’s stock going forward.
1. Decline in company owned stores as McDonald’s re-franchises them
The number of McDonald’s own-operated stores has declined by nearly 24% in the past three years, from more than 8,100 stores at year-end in 2006 to around 6,200 stores at the end of 2009. Most of the reduction in company-operated stores came from converting them to franchised stores, which generate more profit for McDonald’s with fewer operating hurdles.
Going forward we expect re-franchising to continue at slower than historical rates and eventually stop. Because McDonald’s is focused on growing its emerging market penetration through franchisees, we do not expect new company-owned stores to open in significant numbers going forward.
Net: We forecast the total number of McDonald’s operated stores to decline over the next 3-4 years and then level out at around 5,500 stores.
2. McDonald’s franchisee profit margins are 4x times those of company operated restaurants
Franchising is an extremely profitable business, which largely explains why food-service retailers such as McDonald’s, Subway, Burger King (BKC) and Dunkin Donuts prefer franchising their stores to owning them.
McDonald’s own-operated stores had EBITDA margins of around 23% in 2009 as compared to around 88% of franchised stores. The difference in margins results mainly from the extra operating costs incurred by company-operated restaurants, such as payroll and rent. As a result, having more franchised stores increases McDonald’s overall profitability.
3. Company owned stores still important to maintain standards and retain branding
That said, company-owned restaurants remain important because McDonald’s uses them to set operating standards for the much larger population of franchised stores. Company-owned stores also help McDonald’s maintain control over its product lines and introduce new menu offerings in time to keep itself strongly positioned against competitors.
All this helps McDonald’s maintain the integrity of its brand and popularize its franchise business.
Disclosure: No positions