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The Franchisee Tab to McDonald's: $1 Billion and Climbing

By Demitri Kalogeropoulos - May 3, 2020 at 8:00AM

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The fast-food chain has deferred rent and royalty payments as sales trends slumped across its network.

Investors were bracing for bad news from McDonald's (MCD 0.87%) since its global store network was operating at reduced capacity for part of the first quarter. COVID-19 closures plus social distancing efforts were sure to put a major strain on key metrics such as customer traffic, earnings, and cash flow.

The fast-food giant this week revealed that it had been seeing strong growth in January and February, but that things change rapidly during the first few weeks of March. "We're operating in a completely different world," CEO Chris Kempczinski said in a conference call, "and we expect these changes to persist long after the crisis is over."

Four friends eating in a fast-food restaurant

Image source: Getty Images.

Below, we'll look at a few of the management team's biggest takeaways for investors, including the financial hit so far from deferring rent and royalty payments from its franchisees in recent months.

The tough time ahead

This is a challenging and unpredictable time. Looking at comparable sales, we expect the second quarter as a whole to be significantly worse than what we experienced for the full month of March.
-- Kempczinski

Executives celebrated the fact that the company has likely already passed the worst part of the global crisis when it comes to its store assets sitting idle. Late March appears to have been the high-water mark of the mandatory restaurant closures that were widespread in places such as France, Italy, and the U.K.

Yet operating trends will still look worse in the fiscal second quarter, which has started with comparable-store sales down 70% in many international markets and lower by about 25% in the U.S. geography.

The financial impact

Our general philosophy is for any [cash] assistance to be timely, targeted and temporary. The financial health and strength of our franchisees has been a competitive advantage for McDonald's for years. And we expect that to continue post COVID-19.
-- CFO Kevin Ozan

McDonald's generates most of its earnings through charges such as rent, royalties, and fees that are paid by franchisees. But those partners are under significant financial stress today and, in many cases, can't fully meet their commitments. The chain has responded by deferring cash collections for April and May, which so far amount to about $1 billion of liquidity assistance.

The company plans to collect these payments, but cash flow trends are still on pace to drop significantly in 2020. McDonald's is offsetting the challenge by reducing capital investments, suspending stock buybacks, and taking on more debt.

Slow recovery pace

The [Chinese] market continues to experience a reduced level of demand as consumers have not fully returned to their pre-COVID routines, resulting in negative comp sales since the initial outbreak in late January. Comp sales were down over 20% in the first quarter and trends have improved in April to negative mid-teens.
-- Ozan

As the first major economy to go through a national coronavirus outbreak, China shows a potential path that McDonald's business might take globally over the next few months. All of its restaurants are open there today, marking a complete recovery from the 25% closure rate in February.

Shopper traffic is still depressed there, especially in the breakfast hours, which suggests it could take several months before trends start looking normal again.

Yet McDonald's has been encouraged to see an enthusiastic response to its latest Big Mac promotion in China. Kempzcinski said this success "shows that after a prolonged disruption of their daily lives, customers are craving comfort in our iconic core menu of items."

Demitrios Kalogeropoulos owns shares of McDonald's. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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