McDonald’s Economic Moat and Intangible Assets

Investment Thesis

Using a “MCD” framework that encompasses core menu development, pertinent marketing, and the four D’sdigital, drive-thru, delivery, and developmentMcDonald’s strategy centers on its competitive advantages. In a difficult consumer spending climate, the company has been highlighting its value offerings by utilizing its scale-driven cost advantage. McDonald’s marketing initiatives, including the adult Happy Meal promotions, Grimace shakes, and the return of the Hamburglar, have generated a significant amount of brand buzz. With $25 billion in sales of chicken platforms now matching the hamburger chain’s beef platform sales, the company has also repositioned its menu to satisfy the shifting needs of a global restaurant consumer.Following its four “D’s,” McDonald’s is performing well; in its top markets, its digital sales mix accounts for more than 40% of systemwide sales. Its 175 million members worldwide, the installation of dual-lane drive-thrus, a delivery sales mix of 12%13% of systemwide sales, and an increase in unit development goals are the main drivers of this. The burger chain has changed its approach to highlight its value-oriented origins as a result of increased competition. It has also redesigned its value platform and introduced a $5 meal bundle nationwide to close the widening value gap with rivals in the industry.

Investment Upsides

The restaurant business is extremely competitive, with low entry barriers and low switching costs, making it challenging for the majority of operators to create an economic moat. Operators concentrate on creating a significantly distinct and identifiable brand or creating structurally lower operating costs in order to accomplish this, usually with the help of scale-driven cost advantages and leveraged systemwide marketing and technology investments. With pricing power, a robust franchisee network, and successful international replication supporting its brand intangible asset, McDonald’s has a broad economic moat. McDonald’s enjoys a sustainable cost advantage because of its global dominance, which enables it to negotiate lower prices from third-party delivery aggregators, leverage marketing and technology investments across its global footprint, and purchase food and paper at advantageous prices. This view is supported by the firm’s adjusted ROIC forecast of 30% over the next ten years, which comfortably exceeds the operator’s estimated 7% WACC.

The company’s competitive restaurant-level margins, impressive unit volume, and the number-one quick-service restaurant market share by sales volume in every major market it operates in (with the notable exception of China) are examples of intangible assets. Its historical ability to pass on inflation in labor and food costs to customers is another. With average sales per US franchised restaurant of $3.9 million in 2024, McDonald’s performs well overall and significantly outperforms its publicly traded competitors in the hamburger market. Average unit volume, restaurant-level margins, system stability, and franchise return on investment are the factors that influence a brand’s appeal to franchisees. With average sales per US franchised restaurant of $3.9 million in 2024, McDonald’s performs well overall and significantly outperforms its publicly traded competitors in the hamburger market. After controlling for measurement comparability, we estimate that higher sales result in significantly better store-level operating income than many of McDonald’s direct competitors because restaurants have high incremental operating margins.

This conclusion is supported by franchise disclosure documents. McDonald’s dominating size enables it to take advantage of lower prices on third-party aggregator platforms, fixed-cost leverage over general, administrative, marketing, and technology expenditures, and volume discounts in food and paper procurement from food distributors. QSR operators place a high priority on cost and on-time delivery when it comes to procurement relationships. While in-house technological capabilities give chains the advantage of paying for food products without additional services like inventory management, marketing support, or other higher margin (for distributors) consultative offerings, larger case volumes per store help food distributors manage delivery costs per case, especially with costly last-mile delivery.

When developing a global brand, the advantages of scale are crucial, even though marketing and technology expenditures are sometimes overlooked. McDonald’s advertising cooperatives probably keep about $5.2 billion in marketing funds to plan promotions, such as the company’s well-liked adult happy meals, Grimace promotions, limited-time deals, or top-of-funnel brand marketing through traditional print, radio, and digital advertising, given a 4% marketing royalty and $131 billion in 2024 systemwide sales. McDonald’s has made significant technological advancements, including implementing a scheduling program (RGM Boss) in its Chinese market that increased restaurant profitability by 30 basis points, investing in inventory management and simple RFID tracking software, standardizing processes like finance and HR data and best practices through its global business services (GBS) initiative, and making significant investments in its MyMcDonald’s loyalty program. With over 43,000 locations worldwide and a systemwide sales base of $131 billion by the end of 2024, McDonald’s is in a unique position to benefit from technology investments that even slightly increase comparable sales or restaurant margins, giving it an advantage over smaller competitors.

Intrinsic Valuation

The target share price for McDonald’s is $298.69, in line with its current share price.Despite a challenging business environment, McDonald’s is anticipated to keep making investments in its economic moat. During the fourth quarter, the company’s efforts to reestablish its value positioning resulted in positive visitor traffic in its largest US market, which should support continued market share gains in 2025. By offering a McValue menu that has begun to reverse flagging consumer value perception with promotions like “buy one get one for $1” and the company’s well-publicized $5 meal deal, the company is leveraging its scale-driven cost advantage.

As it ramps up its shared services initiative (Global Business Services, or GBS), the company plans to increase its near-term capital expenditures by $300 million to $500 million annually while maintaining its store development targets of 50,000 stores by 2027. These investments ought to fortify the chain’s four-wall economic model and generate long-term value for shareholders. Despite the global pandemic, digital transformation, and the sale of its primarily company-owned Russian market, McDonald’s has demonstrated remarkable success in generating strong comparable-store sales growth. Between 2020 and 2024, the company’s home market saw an average annual growth in comparable store sales of almost 6%, offsetting a significant amount of historically high inflationary pressures without outpacing its core clientele.

While smaller, less capitalised peers reduced investments and found it difficult to cover rising input costs, McDonald’s has had the luxury of investing throughout the cycle. With projections indicating average yearly sales growth of 6.3% and 11.1% through 2029 in internationally operated markets and internationally developed and licensed segments, respectively, the company’s youthful loyalty program, booming digital sales volumes, and unit development continue to propel it to gain market share overseas.

Investment Downsides

A highly franchised business, McDonald’s is regarded as one of the most advantageous operators in the sector. However, a mix-shift towards less expensive food options is being driven by consumer pressure, which may have an effect on pricing power and sales momentum. There is still little industry traffic, and a rise in discounts and promotions points to modest growth in comparable store sales and pressure on margins through 2024 and 2025. Franchisees are more worried because they will probably experience flat to declining margins as they deal with rising labor, real estate, and commodity costs. The largest risk to McDonald’s is human capital, as operators must contend with a revised NLRB joint employer rule and higher minimum restaurant wages in California.

The risk of similar legislation in other politically liberal states is also worth monitoring. The firm’s ability to appeal to changing consumer demands remains crucial, with brand strength demonstrated by pricing power and guest traffic. Deterioration of the brand cachet could slow unit growth, soften restaurant-level profitability, and lead to declining attractiveness for potential franchisees.

Guru Activity

Gurus who increased exposure

Gurus who reduced exposure

If we try to galvanise the above two charts, we can deduce that some of the top line Gurus have offloaded MCD from their portfolios at far larger volume than that of the Gurus who added MCD over the same period. Notable long/short hedge fund has offloaded its 1.24% portfolio exposure on MCD along with long-only funds like Wellington and T. Rowe Price have also trimmed their exposure in the fast food chain by a material volume. This is a signal of a larger market trend where Gurus are embracing the shifting dynamic of consumer lifestyle where consumption of weight-loss drugs by consumers effectively kills cravings and reduces appetite.

Portfolio Management

Because of its low net debt/enterprise value and staggered debt maturities, McDonald’s has a low level of systematic risk on its balance sheet. Nonetheless, its highly franchised operating model allays debtholder concerns by providing tangible assets and lowering cash flow uncertainty. The company makes reasonable investment choices, and over the course of the forecast period, returns on capital invested increased. It was a smart move on the part of the company to refranchise its US store base between 2015 and 2018, increasing the number of franchised stores to 95% and deducting $250 million from general and administrative costs. The company has successfully struck a balance between investing in store performance and unit economics, which is a major investment risk for franchisors, and running a highly franchised, decentralized system.

This article first appeared on GuruFocus.