McDonald’s (MCD) reported its fourth-quarter results on Monday, and they weren’t the greatest.
Revenue fell 0.28% year over year to $6.39 billion, missing expectations of $6.45 billion. Adjusted earnings per share (“EPS”) came in at $2.80 versus the predicted $2.84. And while global same-store sales were a surprise with 0.4% growth instead of a 0.91% decline, they still fell in the U.S. by 1.4%.
Even so, I’m still very optimistic about McDonald’s long-term prospects. The company’s history and my own personal experience with it are too compelling to ignore.
You see, around 20 years ago, I was developing a mixed-use project in Hartsville, South Carolina. After tying up around 100 acres, I secured a deal with Walmart (“WMT”) to anchor a retail center that also included four outparcels.
When I reached out to McDonald’s, it immediately approved the site. But I made sure to stress that they’d be renting from me; I didn’t want to outright sell the space.
I knew that a ground lease from McDonald’s was much more valuable.
Google Maps (Hartsville, SC)
Owning property leased to McDonald’s is like owning a vintage Rolex watch. It appreciates much faster than competing assets.
Rolex, for its part, is known for its expert craftsmanship and attention to detail with the best materials possible. Consumers know there’s no competitor out there that does it quite like Rolex does.
The same applies to McDonald’s. Not when it comes to the ingredients it uses, of course. No comments there. But it is one of the most sustainable businesses on the planet due to its hamburger and real estate empire.
In fact – as I explained last October – McDonald’s real estate business is the most critical part of its business model.
A History of McDonald’s Real Estate Empire
Readers may already know the history of the company. But, if not, it’s worth taking a step back.
It all started in 1940, when Mac and Richard McDonald opened their first McDonald’s restaurant in San Bernardino, California.
At first, the brothers operated the restaurant as a drive-in facility. But in 1948, they modified the concept to include affordable fast food.
Their growing business got Ray Kroc’s attention, a milkshake-machine salesman who wanted to see why they needed so much equipment. And he was so impressed with the business model that he got involved.
What Kroc ultimately wasn’t impressed with was the brothers, as unflatteringly depicted in The Founder. So, he purchased McDonald’s for $2.7 million in 1961. That would be just over $28.6 million when adjusted for inflation.
The movie depicts Kroc as something of a villain. I always thought that was a little unfair. The brothers had a great idea, no doubt. But by their own admission, they’d failed to expand outside of San Bernadino. Were it not for Kroc, McDonald’s as we know it simply wouldn’t exist. And the brothers got nearly $30 million (inflation-adjusted) for their trouble, money they could have easily invested (but apparently never did) in MCD when it went public four years later.
At any rate…
From there, Kroc and his business partner, Harry Sonneborn, created an exceptionally profitable financial model: McDonald’s would own the land on which the franchisees built their stores.
Therefore, they’d be both landlords and restauranters, a model that worked beautifully.
In 1965, McDonald’s was listed on the New York Stock Exchange. Two years later, it opened its first international location in Richmond, British Columbia in Canada.
That saga just kept going from there. By the end of the 1990s, more than 11,000 McDonald’s locations existed outside of the U.S., to say nothing of the continued growth inside.
Today, the company owns or leases more than 41,000 properties, making it one of the world’s biggest real estate companies. Combined with related equipment, that adds up to more than $40 billion in value.
And it plans to hit 50,000 properties by 2027.
This real estate aspect is a vital component of its business model. Its lease arrangements provide control, cost savings, and brand consistency… all while generating additional revenue through sub-leasing or selling excess space to other entities.
In fact, about 95% of McDonald’s stores are franchised today. So the majority of its revenue comes from royalty fees and rent checks – both of which are higher than traditional franchises.
Because, hey. This is McDonald’s!
It’s No. 1 in the U.S. fast-food industry with around 15% of market share. It celebrates its 70th anniversary this year. And it should become a dividend king in 2026 if it increases its dividend for the 50th year in a row.
It pays to play.
Arcos Dorados
As much as I like McDonald’s as a business, though, shares are currently trading at around 26.3 times price-to-earnings (P/E). Since I’m a bargain shopper, I’d much rather wait for a pullback to $280 before I possibly take a bite.
But there is a cheaper way to play the McDonald’s story that I’m currently considering.
I recently came across Arcos Dorados (ARCO) while screening for companies in my small-cap service, Wide Moat Confidential. Based in Uruguay, its name literally means “Golden Arches” in Spanish.
Arcos Dorados operates 2,410 McDonald’s locations in Latin America and the Caribbean, owning the land for around 475 of them. This includes space in Chile, a country I had the privilege to go to a few years back while consulting with a large asset manager.
I fell in love with the real estate there. And I expect to say the same when I travel to Brazil, Chile, and Costa Rica – places where Arcos Dorados operates – in a month or so.
There’s so much potential in these nations, both from a property perspective and from “normal” business growth.
Admittedly, Arcos Dorados is still a smaller company with a $1.77 billion market cap. So it does require more extensive research before I can recommend it. And even if it does end up checking all the boxes…
Those interested should still understand that small caps automatically come with bigger risks. Then again, they also come with greater profit potential – if they succeed.
In Arcos Dorados’ case, its shares are trading at 12.9 times with a 2.9% dividend yield. Whereas its historical valuation is closer to 18 times, and consensus growth is promising.
Think around 14% annually over the next three years.
But even if ARCO doesn’t make the cut, I’m happy with how our small-cap portfolio is progressing.
So far, my Wide Moat Confidential small-cap portfolio consists of a scrappy asset manager based in Omaha… a tiny jet hanger business with an incredible advantage… a seemingly sleepy southeastern grocer that owns most all of its real estate… and a few other wide-moat businesses.
But I’m always looking to expand that list further, and readers should expect a new recommendation next week.
Will Arcos Dorados make the cut? All I can say now is that I’m laser-focused on selecting the most attractive small-cap ideas on the planet.
If you want to follow along on this journey, join me at Wide Moat Confidential. You can learn more right here. I look forward to seeing you there!
Regards,
Brad Thomas
Editor, Wide Moat Daily
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