The eponymous index was dreamt up by some bright spark at The Economist in 1986 as a means of measuring purchasing-power parity, by taking the locally denominated price of the burger in a country, and then dividing it by the price of a Big Mac in the US to arrive at an implied exchange rate. This is then compared to the official rate to determine if the local currency is over- or undervalued against the US dollar.
For example, a Big Mac in the UK will set you back £2.69, while you could expect to pay $3.57 for the same burger in the US. Divide the former by the latter and you get 0.75. The official exchange rate is currently 0.77, suggesting that sterling is undervalued to the tune of 2.6 per cent.
The main point of this, though, is that the Big Mac was chosen because it is produced to a common specification in many countries around the world. Standardisation has been at the heart of McDonald’s operation since US fast-food tycoon Ray Kroc opened the first McDonald's franchise under his partnership with the McDonald brothers in 1945.
The restaurant chain offered low prices, a limited menu and fast service, all made possible through increased automation, uniform production processes and centralised procurement. As the number of its franchises grew, the group developed tremendous purchasing power, largely gaining control over the primary, secondary and tertiary elements of the business.
This vertical integration extended to the operation of its own facilities producing standardised ingredients, which are then transported by the group’s own logistics networks, enabling it to keep a tight rein on distribution costs. The group has also been heavily involved in agricultural production to secure the supply chain from the bottom up.
However, some of the benefits linked to a vertically integrated model have been diluted due to the global expansion of the franchise. And at last count, the group was supported by 141 companies in its supply chain. With growth comes inter-dependency, although the trade-off is perhaps unavoidable.
That McDonald’s has been as successful as it has, for as long as it has, is remarkable given the sector in which it operates. Barriers to entry are relatively low for the fast-food industry, so competition is always intense. Operators in the sector must be prepared – and sufficiently capitalised – to take a periodic hit on margins to preserve market share.
Unfortunately, recent events have presented a challenge that may not have featured prominently in the group’s risk management deliberations. The disruption brought about by Covid-19 has been unprecedented outside of wartime, but the group’s latest figures, though falling short of analyst expectations, point to the resilience of the business.
Total revenue was down 19 per cent year on year, while the fall-away in operating income was double that figure as ancillary expenses increased disproportionately. An additional $45m was set aside for bad debt related to rents and royalty deferrals for the second quarter, while further support is being offered to franchisees.
The key US operations chugged along despite the lockdown, as the lion’s share of restaurants were operating drive-thru, delivery, and/or take-away with a shortened menu. Diners in the international operated markets are not quite so inclined to fill their faces at the wheel, so there was a 41.4 per cent top-line decline over the second quarter, with trading volumes sliding dramatically in both France and the UK. The good news is that 96 per cent of the chain’s 39,000 outlets are currently providing meals in some capacity, against 75 per cent at the start of April.
Prior to the Covid-19 effects, the group had been making significant operational headway, having expanded the adjusted cash margin to 49.5 per cent from 34.9 per cent in 2014, with return on assets up 2.5 percentage points to 15 per cent over the same period. The group’s hefty net debt represents roughly three times cash profits, but its trading profit covers its interest payment by a multiple of 8.5 – superior to the average for the Consumer Cyclical sector.
Same-store sales fell 24 per cent in Q2, though the rate of decline narrowed appreciably through June and July. The main consideration now is whether diners will be inclined to visit the group’s dining rooms when they have all reopened, particularly where face masks are mandated. Maybe chomping at the dashboard is the way to go.
