Fitch Rates McDonald's Proposed $6 Billion Debt Issuance 'BBB+'
OREANDA-NEWS. Fitch Ratings has assigned a 'BBB+' rating to McDonald's (NYSE: MCD) multi-tranche debt issuances. The Rating Outlook is Negative. The $6 billion issuance includes $750 million three-year, $1 billion five-year, $1.75 billion 10-year, $750 million 20-year, and $1.75 billion 30-year fixed rate senior unsecured notes. At Sept. 30, 2015, McDonald's had approximately $18 billion of total debt. A full list of McDonald's ratings follows at the end of this release.
The notes, which rank pari passu with existing debt, are being issued under McDonald's U.S. medium-term notes shelf registration dated Sept. 28, 2012. Terms do not include financial covenants. Proceeds will be used for general corporate purposes, inclusive of share repurchases.
KEY RATINGS DRIVERS
Aggressive Financial Strategy
McDonald's is demonstrating a growing willingness to utilize its balance sheet to increase shareholder returns. On Nov. 10, 2015, McDonald's announced plans to optimize its capital structure and increase cash returned to shareholders via dividends and share repurchases to about $30 billion during the three-year period ending 2016. The goal is $10 billion higher than the company's previously articulated target with the vast majority financed with additional debt. Through the third quarter of 2015, McDonald's returned $7 billion to shareholders, after returning $6.4 billion in 2014. The company had already issued $4.2 billion of debt earlier this year to accelerate share repurchases.
Materially Higher Leverage
Fitch expects total adjusted debt/EBITDAR will increase to and be maintained in the mid-3x range, up from 3.1x at Sept. 30, 2015 and 2.6x at Dec. 31, 2014. Fitch's forecast assumes that McDonald's will generate low-single-digit global same-store sales (SSS) growth in 2016 and 2017 and that EBITDA remains fairly stable to 2015 projected levels of $9.1 billion. Fitch's longer-term forecast incorporates a cumulative $2 billion of cash proceeds from the sale of company units, gradual realization of $500 million of G&A expense savings, and that refranchising has only a slight negative impact on operating income.
Sustainability of Recent Same-Store Sales
During the quarter ended Sept. 30, 2015, global SSS increased 4.0%, after being weak for more than two consecutive years. All segments contributed to the recent improvement. Comparable sales increased 0.9% in the U.S., 4.6% across International Lead markets, 8.9% in High Growth markets, and 6.1% in Foundational markets.
Nonetheless, McDonald's is in the early stages of its turnaround plan. The brand continues to lose market share, particularly in the U.S. where McDonald's reported a 3.2% comp gap to the quick-service sandwich category during the September quarter. Global comparable guest counts are down 3.1% and 3.7% for the nine- months ended September 2015 and September 2014, respectively.
Fitch views a cohesive and aggressive system-wide effort to improve service, emphasize food quality and provide locally-relevant menu variety as necessary catalysts for sustained SSS growth. Due to McDonald's significant size and the need to solidify franchisee support, Fitch believes changes will take time to implement and resonate with consumers.
Shift Towards Higher Mix of Franchised Units
McDonald's intends to increase the percentage of its global system that is franchised to 93% by the end of 2018 from 81% currently by selling 4,000 units to operators. Longer term McDonald's strives to become 95% franchised. Refranchising will mainly occur in McDonald's High Growth and Foundational market segments which are currently 44% and 90% franchised, respectively. High Growth markets include China, Italy, Poland, Russia, South Korea, Spain, Switzerland, and the Netherlands. Foundational markets include various countries outside of the U.S. and International Lead markets (Australia, Canada, France, Germany, and the U.K.).
Fitch views McDonald's decision to reduce the number of company-operated restaurants as consistent with industry trends. Franchising increases the stability and quality of cash flows, given that it produces a steady stream of royalty and rental income and has low capital requirements. Fitch anticipates that capital expenditures will decline meaningfully from approximately $2 billion expected for both 2015 and 2016, if the company successfully meets its goal.
Significant Cost Reductions
McDonald's is targeting $500 million of annualized G&A cost reductions with the vast majority being realized by the end of 2017. The goal represents nearly 20% of McDonald's $2.6 billion expense base at the beginning of 2015. Savings will be realized through refranchising, lower corporate overhead, and greater efficiencies across global business services. The company expects to realize $150 million of savings by the end of 2016. Fitch anticipates savings to accelerate with the pace of refranchising and, along with incremental royalty and rental-based income, to help offset operating income declines associated with the sale of company-operated restaurants.
LIQUIDITY AND MATURITIES
McDonald's liquidity is supported by its large cash balance, FCF (cash from operations less capex and dividends), and an undrawn revolving credit facility that expires December 2019. At Sept. 30, 2015, McDonald's had $5 billion of liquidity consisting of $2.5 billion of cash and $2.5 billion revolver availability. FCF typically exceeds $1 billion annually and was $1.5 billion for the nine months ended September 30. Upcoming debt maturities include approximately $800 million in 2016 and about $1 billion in 2017. Fitch expects maturities to be refinanced given McDonald's shareholder-friendly activities.
--Positive low-single-digit SSS growth of about 2% in 2016 and beyond;
--Operating income grows 5% - 7% in 2016 and declines slightly thereafter due to refranchising;
--Total debt increases to, and is sustained in the $25 billion range;
--Free cash flow (FCF) approximates $1.5 billion in 2016;
--Total adjusted debt-to-operating EBITDAR (defined as total debt plus 8x gross rents-to-operating EBITDA plus gross rents) rises to the mid-3.0x range.
Future developments that may, individually or collectively, lead to a positive rating action include:
--Several quarters of positive low-single-digit SSS and stabilization of market share;
--Meaningful progress with refranchising and realization of cost savings;
--Total adjusted debt-to-operating EBITDAR sustained in the low-3.0x range.
Future developments that may, individually or collectively, lead to a negative rating action include:
--Weak SSS performance in 2016 and continued market share losses;
--The lack of meaningful progress with refranchising and realization of cost savings;
--Total adjusted debt-to-operating EBITDAR sustained in the mid-3.0x range due to weaker than expected operating results and share buybacks.
McDonald's current ratings are as follows:
--Long-term IDR 'BBB+';
--Bank credit facilities 'BBB+';
--Senior unsecured debt 'BBB+';
--Short-term IDR 'F2';
--Commercial paper 'F2'.
The Rating Outlook is Negative.