Morningstar

McDonald's China Sale Makes Strategic Sense

The sale of the firm’s China operations to partners with more expertise in the region should enable faster unit growth, but we aren’t changing our wide moat rating or fair value estimate.

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McDonald's Corp
(MCD)

In a long-anticipated move,

The move will not impact our wide moat or $128 fair value estimate, which assumes 4%-5% average annual systemwide sales growth and operating margins improving from 31% in 2016 to the mid- to high-40s driven largely by management's goal of moving to 93% franchise ownership by 2018 and 95% over a longer horizon. Although we'll make some adjustments to our model for the timing of the transaction, we had already anticipated the refranchising of 1,750 McDonald's company-owned locations in China and Hong Kong the next few years; as such, our longer-term assumptions remain largely unchanged. While trading at a modest discount to our fair value estimate, we'd prefer a wider margin of safety before investors added to current positions.

From a strategic perspective, we remain constructive about this transaction as well as future refranchising efforts. McDonald's China operations have been inconsistent over the past two decades, and we believe the CITIC and Carlyle's expertise in the region will enable faster unit growth--particularly outside Tier 1 and Tier 2 cities--while developing menu, operational, digital, and delivery strategies more suited to Chinese consumers. Additionally, between the proceeds from this transaction and reduced capital responsibilities from future refranchising activity, we would not be surprised to see management target between $15 billion-$20 billion for its 2017-19 shareholder return goal (combining share repurchases and dividends).

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About the Author

R.J. Hottovy

Sector Strategist
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R.J. Hottovy, CFA, is a consumer strategist for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He is responsible for consumer discretionary and staples research. He has covered the consumer sector as an analyst and director of global consumer equity research for Morningstar since joining the company in 2008, and specializes in a broad range of consumer categories including restaurants, footwear and apparel retailers, consumer electronics retailers, fitness clubs, home improvement and furnishing retailers, and consumer product manufacturers.

Before joining Morningstar, Hottovy was a director and senior stock analyst for Next Generation Equity and an analyst for William Blair & Co., specializing in a wide range of retail and consumer product companies. He also spent two years at Deutsche Bank, covering waste management, water utilities, and equipment rental stocks.

Hottovy holds a bachelor’s degree in finance and a second degree in computer applications from the University of Notre Dame, where he graduated magna cum laude. He also holds the Chartered Financial Analyst® designation and is a member of the CFA Institute and the CFA Society of Chicago.

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