What business McDonald’s is really in?
If you think it is selling hamburgers, think again.
Personally, I recall a time when I read Rich Dad Poor Dad by Robert Kiyosaki. From it, I learnt of a story where Ray Kroc, the man who turned McDonald’s into a worldwide fast-food empire, had beer with MBA students after a lecture session. Ray asked these students what business he’s in and one of them, believing that Ray is joking, replied: “Hamburger Business”. To which, Ray had responded that he is not in the hamburger business but in real estate.
Today, I believe McDonald’s is more than just a real estate business. The company’s wealth was and now is built upon a synergy of its franchising systems (business), real estate, and stocks. To this day, while most recognise McDonald’s as a dominant fast-food brand, many don’t know how or where it earns its margins. Here, in this article, I’ll list down 7 things which I learnt after having read the annual reports of McDonald’s.
They are as follows:
1. Store Count
In 2024, there were 43,477 McDonald’s restaurants globally, up from 36,258 in 2014. Typically, it offers a uniformed menu that features the Big Mac, Filet-O-Fish, McChicken, Quarter Pounder & Chicken McNuggets, a standardised breakfast menu that offers Egg McMuffin, hash browns and Sausage McMuffins and a variety of beverage products, including McCafe’s beverages.
Among 43,477 restaurants, McDonald’s owns and operates 2,045 restaurants (4.7%). The other 41,432 restaurants (95.3%) are either franchised or licensed. Both of these business models are different and thus, contributed different profit margins to McDonald’s.
2. Directly Operating Restaurants (DORs)
DORs allow McDonald’s to test its system and innovation before introducing them to restaurants worldwide. Also, McDonald’s uses DORs as training grounds for its personnels. DORs earn food and beverage sales and incur food, paper, staff and occupancy expenses. McDonald’s has, over time, reduced its number of DORs, from 6,714 in 2014 to 2,045 in 2024. This caused revenue to fall from US$ 18.2 billion in 2014 to US$ 9.8 billion in 2024. With a slight dip in operating margin, down from 17-18% in 2017-2021 to 14.8% in 2024, DORs’ operating income fell progressively in the last 10 years, down from US$ 2.9 billion in 2014 to US$ 1.4 billion in 2024.
3. Franchise Restaurants (FRs)
There are three types of franchise restaurants.
The first type is conventional license. Under this arrangement, McDonald’s invests in real estate, where franchised restaurants are being operated at. Its franchisees shall invest in its equipment. Hence, McDonald’s shall earn rental income and royalties based on percentage of sales from its franchisees. This arrangement accounted for around 50% of its total restaurant count globally.
The second type is developmental license. Under the arrangement, its franchisees invest capital to acquire equipment, building and real estate of their restaurants. McDonald’s earns royalties in respect to restaurant sales obtained by franchisees on a percentage basis. McDonald’s now has around 25% of its restaurants under this arrangement.
The third type is foreign-affiliated. This arrangement is similar to developmental license. But, this arrangement is mainly used for markets in China and Japan. McDonald’s owns a 48% interest in Grand Food Holding which operates and manages McDonald’s business operations in Mainland China, Hong Kong and Macao and a 35% stake in McDonald’s Japan Holdings Co. Ltd, which is operating McDonald’s businesses in Japan. From them, McDonald’s earns royalties and income from its equity interests in these entities. Around 30% of McDonald’s restaurants are operated in this manner.
For most parts (except equity interests in China and Japan), McDonald’s had grown its franchise revenues from US$ 9.3 billion in 2014 to US$ 15.7 billion in 2024. With margins at around 80+% in that ten-year period, McDonald’s increased operating income from US$ 7.6 billion in 2014 to a total of US$ 13.2 billion in 2024 from its FR operations.
4. Profitability
In 2014-2024, FRs contributed the bulk of McDonald’s operating income despite not contributing bulk of its total revenues. The key driver to McDonald’s profitability lies in FRs. Thus, specifically to McDonald’s, the more vital measure of its profit-generating ability is in its operating income. In 2014-2024, McDonald’s had raised its total operating income (DORs + FRs) from US$ 7.9 billion to US$ 11.7 billion. With total operating income growing faster than interest costs and taxes, that has contributed to a faster growth in net income from US$ 4.8 billion in 2014 to US$ 8.2 billion in 2024. It worked out to be a 10-year CAGR of 5.6%.
5. Capital Allocation Strategy
In 2015-2024, McDonald’s generated US$ 75.1 billion in operating cash flows and raised around US$ 25.1 billion in debt. From these, McDonald’s had allocated around 41.8% of its cash inflows into share buybacks and 37.3% into dividend payments. Therefore, McDonald’s had consistently returned close to 80% of cash inflows to shareholders in share buybacks and dividends.
6. EPS Growth
Thanks to its continuous share buybacks, McDonald’s has reduced its number of shares from as much as 963 million shares in 2014 to 718 million shares in 2024. Its reduction, coupled with the increase of net income at a CAGR of 5.6%, had contributed to a higher EPS growth rate at 9.0% from US$ 4.85 in 2014 to US$ 11.45 in 2024.
7. Valuation
There are three valuation tools: P/E Ratio, dividend yields and P/OCF Ratio.
The first is P/E Ratio. In 2015-2024, McDonald’s P/E Ratio averaged at 26.6. Its P/E Ratio could be compared with McDonald’s earnings growth rate of 9.0% per annum in that period.
The second is dividend yields. In this period, McDonald’s average dividend yield is 2.37% a year and this is excluding a 30% withholding tax on dividends received, if you are a non-US resident.
The third is P/OCF Ratio. In 2015-2024, McDonald’s P/OCF Ratio averaged at 21.33.
Conclusion:
The primary sources of McDonald’s income lies in real estate rental and royalties, not that much from hamburgers. While it revealed its plans to open a net 1,800 restaurants worldwide, which is around 4.1% of 43,477 restaurants in 2024) in 2025, McDonald’s has leasing arrangements with existing franchisees on its real estate which include rent escalations and renewal options. These escalations vary by markets and it is inclusive of fixed-rent escalations and inflation-index based escalations. They would contribute to McDonald’s rental income in the future.
All in all, the key before investing lies in comparing McDonald’s growth rates and valuation ratios with its other listed peers to make a more suitable decision for ourselves.
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