Fitch Downgrades McDonald's IDRs to 'BBB+/F2'; Outlook Stable

CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has downgraded the Issuer Default Ratings (IDRs) of McDonald's Corporation (NYSE: MCD) to 'BBB+/F2' from 'A/F1'. The Rating Outlook is Stable. At March 31, 2015, McDonald's had $14.3 billion of total debt.

A full list of ratings is provided at the end of this release.

KEY RATINGS DRIVERS

Materially Higher Leverage Anticipated

The downgrade reflects Fitch's view that McDonald's has become more aggressive with its financial strategy and also concerns about continued sales declines, market share losses, and brand strength going-forward. McDonald's plans to return $8 billion to $9 billion of cash to shareholders via dividends and share repurchases in 2015 and to achieve the high end of its three-year $18 billion to $20 billion cash return target by the end of 2016.

Given softness in its business, as evidenced by weak first quarter results, McDonald's will have to incur substantial debt to satisfy its cash return goal. Fitch projects that total debt/EBITDA and total adjusted debt/operating EBITDAR will increase to the low 2.0x and 3.0x range by the end of 2015, up from 1.5x and 2.6x for the LTM period ended March 31, 2015.

Fitch has taken into consideration the potential for meaningful cash proceeds and margin accretion from refranchising 3,500 company-operated units by 2018 and the $300 million of annual net G&A savings expected by 2017. However, the pace at which benefits from refranchising will be realized is uncertain, and it is Fitch's view that management may be willing to maintain higher amounts of leverage going forward.

Persistently Weak Same-Store Sales Trends

During the quarter ended March 31, 2015, McDonald's global SSS were negative 2.3% with declines across all major geographic segments. Global guest counts fell 4.7%, an acceleration versus the 3.1% decline in the comparable period last year. McDonald's global SSS have been weak for more than two consecutive years. 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 SSS growth. However, due to McDonald's significant size, the need to solidify the support of franchisees and reputational challenges both domestically and following supply chain issues in Asia, Fitch believes changes will take time and be challenging to implement and to resonate with consumers.

Efforts in the U.S. include simplifying its menu to improve service and provide flexibility to address local customer preferences while also introducing new higher quality food items nationally. In order to appeal to health conscious consumers, McDonald's announced plans to serve only antibiotic-free chicken in the U.S. within two years. The company also recently rolled out a new sirloin burger and is testing a new customizable burger platform in the U.S. called Taste Crafted. Fitch believes improving the brand's perception in the burger category could prove challenging given increasing levels of competition from a growing number of smaller faster growing chains.

Significant Restructuring Under Way

On May 4, 2015, McDonald's new CEO outlined initial steps of his plan to turnaround performance. The company's first priority is to address operational issues, but management also plans to continue to evaluate opportunities to enhance shareholder value. Fitch believes the May 4 announcement provided few additional specifics on how McDonald's will improve consumers' perception of its food but instead focused on organizational changes, becoming 90% franchised globally, and boosting shareholder returns.

McDonald's will realign its business into four market segments to better share ideas and speed decision making across geographies. Segments include the U.S., International Lead Markets (Australia, Canada, France, Germany and the U.K), High-Growth Markets (China, Italy, Poland, Russia, South Korea, Spain, Switzerland and the Netherlands), and Foundational Markets (the remaining markets within McDonald's system). In addition, as mentioned previously, the company also intends to accelerate cash returned to shareholders in 2015, refranchise 3,500 company units by 2018, and reduce annualize G&A by $300 million by 2017.

Substantial but Declining Cash Flow

McDonald's generates substantial cash flow from operations. However, CFO declined 11% during the first quarter of 2015, after declining 5% in 2014 to $6.4 billion due to lower sales and operating income. McDonald's is slowing new unit growth to focus on regaining sales momentum. 2015 Capex guidance is approximately $2 billion, down from $2.6 billion in 2014 and a high of $3 billion in 2012. Free cash flow (FCF - defined as CFO less capex less dividends) remains meaningful, totaling $931 million in 2014 and $490 million in the first quarter of 2015, but Fitch expects FCF to be deployed towards share buybacks.

Liquidity and Maturities

McDonald's liquidity is supported by its large cash balance, FCF, and an undrawn revolving credit facility that expires December 2019. At March 31, 2015, liquidity totaled $4.1 billion and consisted of $1.6 billion of cash and $2.5 billion revolver availability. At the year ended Dec. 31, 2014, debt maturities approximated $1.1 billion in 2015, $823 million in 2016, and $1 billion in 2017 based on year-end currency rates. Fitch currently expects debt maturities to be refinanced given McDonald's shareholder friendly activities.

KEY ASSUMPTIONS

--Low single-digit SSS declines continue in the near term;

--Margins contract in 2015 but expand meaningfully thereafter due to refranchising and cost reductions;

--Operating cash flow growth does not resume until 2016;

--Total debt-to-operating EBITDA and total adjusted debt-to-operating EBITDAR (defined as total debt plus 8x gross rents-to-operating EBITDA plus gross rents) approximate the low 2.0x and low 3.0x range in 2015 and declines only modestly thereafter, assuming no material debt paydown.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to a negative rating action include:

--SSS declines accelerate and remain negative beyond 2015;

--Margin contraction continues post 2015 due to continued weak operating results and a slower than expected pace of refranchising;

--Total debt-to-operating EBITDA and total adjusted debt-to-operating EBITDAR sustained above the mid-2.0x and mid-3.0x range, respectively.

Future developments that may, individually or collectively, lead to a positive rating action include:

--A sustained period of SSS growth;

--Margins stabilize or expand significantly due to operating earnings growth or refranchising;

--Total debt-to-operating EBITDA and total adjusted debt-to-operating EBITDAR is sustained below at or below 2.0x and 3.0x, respectively due to operating income growth or debt reduction.

Fitch has downgraded McDonald's ratings as follows:

--Long-term IDR to 'BBB+' from 'A';

--Bank credit facilities at to 'BBB+' from 'A';

--Senior unsecured debt to 'BBB+' from 'A';

--Short-term IDR to 'F2' from 'F1';

--Commercial paper to 'F2' from 'F1'.

The Rating Outlook is Stable.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 2014);

--'2015 Outlook: U.S. Restaurants - Bucking the Status Quo, Brands Transform to Satisfy Astute Diners, Arduous Investors' (December 2014);

--'McDonald's Corporation - Full Rating Report' (April 2015).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

2015 Outlook: U.S. Restaurants (Bucking the Status Quo, Brands Transform to Satisfy Astute Diners, Arduous Investors)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=839828

McDonald's Corporation

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=863218

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=984368

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Fitch Ratings, Inc.
Primary Analyst
Carla Norfleet Taylor, CFA
Senior Director
+1-312-368-3195
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Bill Densmore
Senior Director
+1-312-368-3125
or
Committee Chairperson
Michael Weaver
Managing Director
+1-312-368-3156
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
[email protected]

Source: Fitch Ratings

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