If You Suppose McDonald’s Makes Cash From Hamburgers and Fries, Then You will Be Shocked by What Its Actual Enterprise Is
On a typical Saturday afternoon, teenage me would discover himself at a northeast Florida McDonald’s (MCD 0.22%) after a full day of browsing with associates. I did not even have to consider my order as a result of I already knew what I used to be getting: two McDoubles and one McChicken. On my teenage funds, that was the most important bang for my three bucks.
Very like my grandfather complaining in regards to the issues that not value a nickel, it is onerous to not really feel nostalgic for that previous McDonald’s Greenback Menu after I dine on the double arches now roughly 20 years later — my teenage order prices $7 or extra as we speak, relying on location. However it’s solely logical for the corporate to lift its costs to make more cash, proper?
In actuality, McDonald’s would not make large cash from its menu. Via the primary three quarters of 2023, the corporate has generated greater than $7.3 billion from one thing that has nothing to do with hamburgers or french fries. And it is surprisingly the most important single income for the corporate.
Much more importantly for traders, this underappreciated enterprise mannequin may very well be its true competitive advantage, in any other case generally known as a moat.
McDonald’s “secret” enterprise empire
Harry J. Sonneborn was an early insider at McDonald’s and has been quoted as saying: “We aren’t technically within the meals enterprise. We’re in the actual property enterprise.” That is proper, Mickey D’s is among the largest actual property empires on the earth.
As of the third quarter of 2023, there are 41,200 McDonald’s areas in over 100 international locations. And but, the corporate itself operates solely about 2,100. The remaining are owned and operated by its many franchisees.
The corporate has comparatively few restaurant areas of its personal, so one would assume that it would not personal a lot actual property. However the steadiness sheet reveals that it has property and gear valued at $42 billion.
Administration realized the advantage of proudly owning actual property early on. Due to this fact, it owns numerous the areas that its franchisees function. In return, franchisees should make rental funds each month along with franchise charges.
As talked about, McDonald’s has earned over $7.3 billion in rental earnings to date in 2023. This represents 63.5% of the income it has generated from its franchisees this yr. And it represents 38% of the corporate’s general income, making actual property the most important moneymaker.
Circling again to my McDoubles and McChicken
McDonald’s owns and operates solely about 5% of its areas. That mentioned, company-owned areas do provide a whole lot of income. It’s because meals gross sales are the identical as income at company-owned areas.
Via the primary three quarters of 2023, company-owned gross sales accounted for 38% of whole income for McDonald’s. Nevertheless, these gross sales solely equipped a paltry 12.6% of the corporate’s general operating profit. Like I mentioned, the large cash comes from what it makes from its franchisees, not meals.
To be clear, McDonald’s should nonetheless make sure the success of its franchisees — in the event that they fail, it fails. The costs on its worth menu (together with my beloved McDouble and McChicken) have consequently elevated as a result of franchisees wanted to make a revenue, and sure menu gadgets had been priced too low.
Menu costs aren’t irrelevant for McDonald’s, however the firm itself would not make the vast majority of its revenue from meals — that is the purpose.
Traders cannot overlook that profits matter tremendously in the case of long-term inventory efficiency. Due to this fact, it is nice to know that income for McDonald’s come from the way more predictable and sturdy actual property market.
The McMoat round its fast-food fort
When McDonald’s determined to show to a 95% franchised mannequin, it affected the highest line. Income is down about 11% over the previous decade, however the firm exchanged a low-margin income supply (meals gross sales) for a higher-margin one (franchise charges and rental earnings).
Due to this fact, McDonald’s gross profit and earnings per share (EPS) are counterintuitively up though income is down, because the chart under reveals. And this leaves extra money for rewarding shareholders with dividends and share repurchases, resulting in nice whole returns.
MCD total return price information by YCharts. TTM = trailing 12 months.
A great portion of McDonald’s income and revenue comes from a predictable supply: its relationship with its franchisees. No matter what occurs within the economic system or with competitors, this earnings stream can have relative stability. For this reason I check with actual property as a kind of moat for McDonald’s.
In The Little Ebook That Builds Wealth, creator Pat Dorsey writes, “Once you purchase shares of the corporate with the moat, you are shopping for a stream of money flows that is protected against competitors for a few years.” That is what I see for traders who purchase McDonald’s inventory as we speak.
