The Incredibly Shrinking McDonald’s

The revenue losses have started at McDonald’s (NYSE: MCD) again. Disturbingly, the 2017 revenue gains were erased by losses over the past three quarters.

McDonald’s started 2017 with $6.029 billion in quarterly revenue for 4th Quarter 2016. That fell to $5.66 billion for 1st Quarter 2017, rose slightly to $6.5 billion for 2nd Quarter 2017, dropped to $7.55 billion for the 3rd quarter of 2017, fell to $5.34 billion for 4th Quarter 2017, and hit a new low of $5.139 billion in 1st Quarter 2018.

Get the picture folks, McDonald’s quarterly revenue fell to a new low in 1st Quarter 2018, despite all the supposed improvements. McDonald’s is still plagued by serious revenue losses that are getting worse.

McDonald’s Revenues Shrank by more than $5 billion in Four Years

By my calculations, McDonald’s’ annual revenue fell by $5.285 billion between December 2013 and December 2017. McDonald’s reported $28.105 billion in revenues on 31 December 2013, and $22.82 billion in revenues on New Year’s Eve 2017.

Our friends at Stockrow calculated that McDonald’s’ revenues shrank by 7.32% in 2017. That was more than double the 3.11% revenue shrinkage reported in 2016. Although it was slightly better than the 7.39% revenue drop reported back in 2015.

Most telling, McDonald’s has not experienced annual revenue growth since 2013 when the rate was 1.95%. Disturbingly that growth was completely erased in 2014 with a 2.36% drop in revenue.

McDonald’s is on the Verge of a Catastrophic Revenue Collapse

The implications are obvious McDonald’s is suffering permanent revenue shrinkage that is increasing dramatically. If McDonald’s 2018 financial performance is a repeat of 2017, revenues might drop by 14% or more.

That would be a revenue drop of $3.1948 billion which would be reminiscent of Sears Holdings (NASDAQ: SHLD). For the record, Sears’ revenues fell by 24.56% or $5.43 billion during 2017.

McDonald’s’ appears to be on the verge of a catastrophic revenue collapse rivaling the epic fall of Sears. Frighteningly, investors don’t seem to have noticed McDonald’s stock was trading at $157.54 a share on 31 July 2018.

Surprise McDonald’s is still Making a Lot of Money

It is easy to see why many investors are still bullish on McDonald’s the company is still making money.

McDonald’s reported a gross profit of $2.528 billion, an operating income of $2.143 billion, and a net income of $1.375 billion for 1st Quarter 2018. That gave the company an operating cash flow of $1.645 billion and a free cash flow of $1.64 billion for that period.

McDonald s also reported cash and equivalents of $2.468 billion March 31, 2018. That figure was slightly over half of its $5.139 billion 1st Quarter revenue.

Skeptics will want to know where the money is coming if the revenue keeps falling. The answers are both simple and rather disturbing.

Why is McDonald’s Making Money?

First, McDonald’s is one brand that still does a huge cash business. A disproportionate number of its customers are lower income individuals who are more likely to pay with cash.

McDonald’s also has a large footprint in Europe, particularly the UK, where people are more likely to use cash. Note: this makes McDonald’s very vulnerable to the foreign exchange rate; the cost of turning Euros or Pounds into dollars. Since both the Euro and the Pound Sterling are worth more than the dollar, McDonald’s loses money when it brings cash home.

Second, McDonald’s makes a lot of money from franchising, selling people the right to start McDonald’s restaurants. Around 90% of the world’s 37,000 McDonald’s are franchised, QSR Magazine pointed out.

Will Franchising Kill McDonald’s?

McDonald’s’ is now in the business of selling franchises rather than hamburgers. That can be problematic because what sells a franchise to an investor is not what sells fries to the average consumer.

One obvious problem is that a lot of franchise investors are the kind of people who would be embarrassed to be seen eating at McDonald’s. They may know little or nothing about the fast-food business.

A worse problem is that McDonald’s is very good at putting on a show that portrays it as a big, profitable brand. The company builds lots of restaurants, and runs lots of TV ads to create a big image. That does not automatically translate into big sales.

To pump up the brand, McDonald’s HQ sends lots of press releases about its initiatives such as “quality burgers,” McCafe Coffee, breakfast all day, UberEats delivery, mobile-pay, and cage-free eggs. The press releases are aimed at investors not McDonald’s customers, which is the problem.

McDonald’s Mountain of Debt

Those initiatives have not created more sales at McDonald’s but they have led to a mountain of debt; $30.870 billion on March 31, 2018. That was up from $27.207 billion on March 31, 2017.

McDonald’s debt grew by $3.663 billion between March 2017 and March 2018, while its revenues fell by $1.78 billion or 7.32% during 2017. That business model is obviously unsustainable and it looks a lot like the mess at Sears.

What’s truly scary is McDonald’s debt level now approaches the value of its total assets which was $33.773 billion on March 31, 2018. That debt already exceeds the value of the non-current assets which was $28.814 billion on 31 March 2018.

The situation with liabilities is even worse, McDonald’s total liabilities now exceed total assets by nearly $5 billion. McDonald’s reported $38.442 billion in total liabilities on March 31, 2018.

Is McDonald’s in the Death Spiral?

That looks very close to the death spiral to me. The death spiral occurs when a retailer’s revenues no longer cover its cost of operations. That forces the retailer to either borrow money or sell or close locations to stay in operation.

McDonald’s is now in the borrow, borrow, and borrow some more stage of the death spiral. That only makes things worse because creditors keep raising the cost of borrowing. Eventually, the retailer finds all its cash going to the creditors, which is a great deal for the creditors.

That of course will be followed by the inevitable, shut down or sell locations to raise cash fast stage. A likely scenario is that at some point in the next two years McDonald’s will start selling off a lot of the US real estate it owns.

The Great McDonald’s Sell Off

McDonald’s owns or leases a lot of choice locations in major American cities. Its competitors; including quality fast-food chains like Chipotle (NYSE: CMG) and Shake Shack (NYSE: SHAK), are expanding fast and would love to get their hands on many McDonald’s locations.

Also in the market will be retailers like Amazon (NASDAQ: AMZN), Aldi, and possibly Kroger (NYSE: KR) which are planning to open hundreds of smaller locations. Many of those retail outlets will be in urban areas, where McDonald’s has restaurants.

Like Sears, McDonald’s may try to survive by selling off real estate. The situation at Sears demonstrates that is no strategy and good way to accelerate the death spiral. One obvious reason for selling real estate is to pay down debt, which McDonald’s will need to do soon.

McDonald’s Dividend is Unsustainable

One thing is clear at McDonald’s both the stock price and dividend are unsustainable with the current financials.

There is no way pay outs like the $1.01 dividend scheduled for September 18, 2018, can continue. Nor is a dividend increase like the jump from 94¢ on August 30 2017 to $1.01 on November 28, 2017, likely.

Skeptics will say that the real reason for the McDonald’s dividend is to pump up the stock price. It looks as if money that should be spent to improve the brand, is being used to bribe investors.

McDonald’s is heading for a massive drop in stock price and dividend payout. That will occur when Mr. Market realizes this stock has little or no value.

Stay away from McDonald’s stock, because it is a company on the fast track to disaster. My prediction is that McDonald’s is headed for a massive fall from which it may not recover.