On lazy Saturday afternoons, my teenage self would head to a McDonald's in northeast Florida after a day of surfing with friends. Without hesitation, I would order two McDoubles and one McChicken – the ultimate bang for my three bucks. Fast forward 20 years, and that same order would cost me $7 or more. But here's the surprising part: McDonald's isn't raking in the big bucks from its menu. In fact, the company has a secret strategy that has nothing to do with hamburgers or fries, and it's generating billions of dollars in revenue.
McDonald's: The "Secret" Real Estate Empire
Harry J. Sonneborn, an early insider at McDonald's, once said, "We are not technically in the food business. We are in the real estate business." Yes, you read that right – Mickey D's is one of the largest real estate empires worldwide. With over 41,200 locations in more than 100 countries, only about 2,100 of them are operated directly by the company. The rest are owned and operated by franchisees. Surprisingly, despite having relatively few company-owned locations, McDonald's owns a staggering $42 billion worth of real estate and equipment.
Recognizing the benefits of real estate ownership early on, McDonald's made sure to acquire a significant number of locations that its franchisees operate. As a result, franchisees pay monthly rental payments in addition to franchise fees. In 2023 alone, the company has earned over $7.3 billion in rental income, accounting for 63.5% of its revenue from franchisees and 38% of its overall revenue, making real estate its biggest revenue generator.
The Role of Company-Owned Locations
Although McDonald's owns and operates only about 5% of its locations, these company-owned locations still contribute a substantial amount of revenue. Since food sales are considered revenue at company-owned locations, they play a significant role. However, while company-owned sales accounted for 38% of the company's total revenue in the first three quarters of 2023, they only contributed a mere 12.6% of the overall operating profit. In essence, the majority of McDonald's profit comes from what it makes from its franchisees, not the food it serves.
It's crucial to note that McDonald's still depends on the success of its franchisees. If they fail, the company suffers. As a result, menu prices, including items like the beloved McDouble and McChicken, have increased to ensure franchisees can make a profit. However, the key takeaway is that McDonald's primary profit driver is not food sales but the stable and profitable real estate market.
The McMoat Protecting the Fast-Food Empire
When McDonald's transitioned to a 95% franchised model, it did impact its top-line revenue, which decreased by about 11% over the past decade. However, this shift allowed McDonald's to exchange a low-margin revenue source (food sales) for a higher-margin one (franchise fees and rental income). Consequently, the company's gross profit and earnings per share (EPS) have increased, as shown in the chart below. This strategy has provided more funds for rewarding shareholders with dividends and share repurchases, resulting in excellent total returns.
A substantial portion of McDonald's revenue and profit comes from its stable and predictable relationship with its franchisees. Regardless of economic changes or competition, this income stream remains relatively stable. This is what makes McDonald's real estate holdings a valuable moat for the company.
In his book "The Little Book That Builds Wealth," author Pat Dorsey explains, "When you buy shares of a company with a moat, you're buying a stream of cash flows that is protected from competition for many years." This is precisely the case for investors who choose to buy McDonald's stock today.
Remember, when it comes to long-term stock performance, profits matter significantly. Therefore, knowing that McDonald's derives its profits from a reliable and robust real estate strategy should provide confidence to investors.
Jon Quast has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. The Motley Fool is a USA TODAY content partner offering financial news, analysis, and commentary designed to help people take control of their financial lives. Its content is produced independently of USA TODAY.
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