Moody's Investors Service downgraded McDonald's Corporation's (McDonald's) (NYSE: MCD) senior unsecured ratings to Baa1 from A3 and affirmed its short term commercial paper rating at Prime-2. The downgrade reflects the company's recent announcement that it intends to increase its returns to shareholders, the vast majority of which will be funded with additional debt. Moody's views this increase as McDonald's maintaining an aggressive financial policy that will result in a material deterioration in credit metrics and limit its financial flexibility. The ratings outlook is stable.

Ratings downgraded are;

Senior unsecured notes and debentures downgraded to Baa1 from A3

Senior unsecured bank credit facilities downgraded to Baa1 from A3

Subordinated shelf rating downgraded to (P)Baa2 from (P)Baa1

Senior unsecured Medium Term Note program downgraded to (P)Baa1 from (P)A3

Subordinated Medium Term Note program downgraded to (P)Baa2 from (P)Baa1

Ratings affirmed are:

Short term commercial paper rating affirmed at Prime-2

RATINGS RATIONALE

The downgrade was prompted by McDonald's recent announcement that it will increase its cash return to shareholders target to $30 billion for the 3-year period ending 2016 with the vast majority of the incremental cash return of $10 billion being funded with additional debt. McDonald's previous shareholder return target was at the high end of its $18 to $20 billion range.

"Overall, Moody's views this debt financed share repurchase initiative as McDonald's maintaining an aggressive financial policy towards shareholders that will result in significantly higher debt levels, weaker credit metrics and further limit its financial flexibility." stated Moody's Senior Credit Officer Bill Fahy. Moody's estimates that in the event McDonalds funds the additional $10 billion return to shareholders with between $7.0 to $9.0 billion of new debt, leverage on a debt to EBITDA basis would be between 3.3 times to 3.5 times on a pro forma basis for the LTM period ending June 30, 2015 versus actual leverage of about 2.7 times. "In addition, McDonald's ability to strengthen credit metrics from these elevated levels could be challenging in the event the company's turnaround plans and business restructuring were delayed or fell short of expectations or shareholder returns increased. Moreover, even in the event of a sustained improvement in operating performance, management's willingness to strengthen credit metrics from these elevated levels remains highly uncertain given McDonald's financial policies to date.

The Baa1 senior unsecured rating recognizes the global strength of the McDonald's brand, its excellent geographic diversity, a steady pipeline of new product offerings, leading market position, strong cash flow and excellent liquidity, and a healthy franchise network. It also reflects the earnings stability created by the fact that the majority of McDonald's operating income is derived from recurring rental income and franchise fees from its extensive franchisee network. However, Moody's also considers management's shareholder focused financial policies with regards to dividends and share repurchases, cash flow credit metrics that will be significantly weaker than for a Baa rating category, as well as the high level of promotional activity within the U.S. quick service restaurant segment and increased challenges in certain international markets that continue to pressure earnings.

The stable outlook reflects our view that despite weak same store sales performance McDonald's brand strength and solid base of franchisees around the world will continue to produce strong earnings and stable cash flows.

Factors that could result in an upgrade include a sustained improvement in operating performance and positive same store sales that drives stronger earnings, debt protection metrics and liquidity. A higher rating would require McDonalds to achieve and sustain debt to EBITDA below 3.25 times and EBIT to interest above 6.0 times. A higher rating would also require maintaining a conservative financial policy in regards to debt financed share repurchases.

Factors that could result in a downgrade include a sustained weakening of same store sales or earnings, or a deterioration in credit metrics with debt to EBITDA approaching 3.75 times or EBIT coverage of interest approaching 4.0 times. A deterioration in liquidity for any reason could also pressure the ratings.