UPDATE: S&P Cuts McDonald's (MCD) to 'BBB+'; Notes Increased Leverage on Sharply Higher Debt Load for 2016

(Updated - November 10, 2015 2:56 PM EST)

Standard & Poor's Ratings Services lowered all of its ratings, including the corporate credit rating, on McDonald's Corp. (NYSE: MCD) to 'BBB+' from 'A-'. The outlook is stable. The commercial paper rating remains 'A-2'.

The downgrade reflects our assessment of the higher leverage from the sharply higher debt load planned in 2016 to return an additional $10 billion of cash to shareholders by the end of next year. Overall, we believe this approach marks a significant and rapid shift in financial policy for the company. Our assumption is that debt to EBITDA will rise to the low- to mid-3x range during 2016-2017 versus around mid-2x previously. We expect the company will also receive cash from the increased refranchising, but assume it will use the cash to support the return of capital to shareholders. We think results will benefit from cost reductions, but we believe McDonald's will continue to keep a high priority on allocating capital to shareholders, even as they execute on new strategies to improve operations in key markets.

The stable outlook reflects our expectation that after borrowing at least $8 billion during 2016 to return capital to shareholders, McDonald's will moderate share repurchases while continuing to work to return revenue growth and customer traffic. We assume they will maintain leverage of less than 4x. We believe the new CEO remains focused on a wide range of initiatives. Still, the competitive environment is fierce and benefits from lower gas prices seem to be moderating for the restaurant sector overall.

We would lower the rating if the company increases its return of capital to shareholders beyond current planned levels while experiencing limited improvement in customer response (improved traffic and positive comparable sales in the U.S. for example) during the next year to 18 months.

Greater distributions to shareholders and lack of recovery from new strategies would lead to credit measures to worsen toward 4x. One scenario leading to a lower rating would be continued negative comps in the U.S., lack of return to growth in the Chinese market and additional debt of around $2 billion to $3 billion in 2016. This performance would lead us to lower the rating to at least 'BBB' because of our view of the worsening financial profile and possibly a less favorable view of the business if operational weakness persisted.

Longer term, a higher rating is unlikely even if the company's turnaround actions for operating performance gains traction with consumers, since we believe the company will remain focused on return of capital to shareholders.

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