Finance case study- Mcdonald\'s + Qantas PDF

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Finance Case Study- McDonald’s + Qantas o Qantas is Australia’s national airline employing 28,000 employees globally. o McDonald’s is a leading multinational fast food corporation with a market valuation of more than US $125 billion. Role of financial management

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Strategic role of financial management Financial management at M’s is concerned with how assets are used, how assets are financed (via debt or equity) and the overall profitability of the company.

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At the core of financial management is a comprehensive accounting system, that collates information into financial reports, which are then used to make strategic decisions. SUMMARY: KEY FACTS - M operates globally, using numerous legal entities

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85% of M stores globally are owned independently by franchisees. M’s aimed to make this figure 93% by the end of 2017. M’s owns or leases the land and the physical shop that a franchise operates in. it then rents this out to the franchisee. M’s is paid regular rent and royalty payments from franchisees. The company makes more money from this that it does selling burgers at its own stores.

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M’s management is continuing to increase the overall debt of the company

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Objectives of financial management M’s uses a mixture of past-year results, overall future plans and general economic conditions to set objectives for future time periods. In 2017, M’s announced some long-term financial targets.

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 Profitability PROFITABILITY (increase profit) Increase operating margin to mid-40%  Growth GROWTH (increase growth) M’s aims for system wide sales growth between 3% and 5% each year (total sales for all global stores). M’s aims to increase the number of restaurants globally by 400 in 2017  Efficiency

EFFICIENCY (increase efficiency) M’s aims to reduce general and admin expenses by US $500 million in 2017. By 2019, management is planning to reduce expenses by an extra 5-10%.

 Liquidity LIQUIDITY (reduce by returning cash to shareholders) Retain sufficient cash to pay outgoings

 Solvency SOLVENCY (increase debt/return equity to shareholders) Continue returning cash to shareholders

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Interdependence with other key business functions Qantas: finance depends on marketing to generate funds. Marketing strategies like Qantas’ new lounges and new check in facilities are expensive and must be funded. HR requires funds to remunerate staff and for funding effective HR strategies like training and development- Qantas spends over $275 million p.a. on staff training.

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Operations needs funds e.g. Qantas has budgeted to spend billions over the next 10 years on fleet renewal.

Influences on financial management

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Internal sources of finance retained profits

INTERNAL SOURCES OF FINANCE: RETAINED PROFITS - M’S has significant retained profits that have accumulated since 1965. The 2016 Annual Report shows retained profits of US $46.2 billion. - M’s has been using a component of the cash associated with retained profits to fund share buy backs and dividends. - M’s current position is to return excess cash to shareholders through dividends and share buy backs. - In the 2015 annual report they said the move away from equity finance to debt was deliberate and aimed at optimising the company’s capital structure. M’s now have negative equity, as a result of the dramatic increase in debt. - External sources of finance

 Debt – short-term borrowing (overdraft, commercial bills, factoring), long-term borrowing (mortgage, debentures, unsecured notes, leasing) EXTERNAL SOURCES OF FINANCE: SHORT TERM DEBT OVERDRAFT: M’s has available a US $2.5billion overdraft, which it is presently not using. However, if needed it can provide a quick source of short-term finance. COMMERCIAL BILLS: - M’s issues “commercial paper” to the public to raise funds. They also raise funds through its global medium-term notes facility (borrowing from individuals and returning a fixed repayment). - In the last 2 years, the company has increased its overall long-term debt from approx. US $14 billion to US $26 billion. Total liabilities were over US $33 billion as at December 31, 2016. LONG TERM DEBT MORTGAGE: - Because M’s franchisees rarely own the land where their restaurants are, they would be unable to take out a traditional mortgage for their store, however they may take out a chattel mortgage for certain assets, whereby the lender keeps a legal right to the financed asset whilst money is owed (could include machinery) LEASING: - M’s makes use of leasing as a source of funding. - In 2016, M’s leased 14,763 stores. These include leases for land and buildings, usually for 20 years. - M’s Australia’s share of leases paid on property in 2016 was over AU $120 million. - At present, M’s has future payment obligations in relation to lease contracts of over US $ 12 billion. - M’s leasing strategy can reduce the initial capital outlay needed for new stores, enabling more stores to be opened in a shorter timeframe. - It also retains cash in the business that can be used for other purposes. - As the vast majority of these stores are then leased to franchisees, M’s uses this strategy to match cast outflow with cash inflow. UNSECURED NOTES/DEBENTURES - M’s has borrowed cash at fixed interest rates for periods of up to 60 years using unsecured notes and debentures.

 Equity – ordinary shares (new issues, rights issues, placements, share purchase plans), private equity EQUITY

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M’s Corporation initially raised capital when it floated on the NY Stock Exchange on April 21, 1965. M’s has issued 1,660 million shares. As at 31st December, 2016, 819 million shares were still in the market and M’s had 841 million shares in its own treasury. M’s consistently pays its shareholders a high dividend M’s is buying back shares from shareholders At the store level, M’s requires new franchisees to have at least 25% of the total cost of a new M’s restaurant in cash (i.e. equity). New stores cost franchisees at least AU $1.2 million- so franchisees must have at least AU $300,000 to invest.

Financial institutions – banks, investment banks, finance companies, superannuation funds, life insurance companies, unit trusts and the Australian Securities Exchange

FINANCIAL INSTITUTIONS - M’s uses many bank and finance companies globally to fund its operations. - They must abide by the rules of NY Stock Exchange, which include frequently disclosing financial and other key information publicly. - Financial rating agencies, like Moody’s influence finance at M’s. - They assess M’s financial position and performance and assign its financial instruments (like debentures and commercial notes) a credit rating. The lower the rating, the harder these instruments are to sell and vice versa. - Influence of government – Australian Securities and Investments Commission, company taxation GOVERNMENT INSTITUTIONS - By operating in around 120 countries, M’s is influenced by the laws, policies and regulations of many governments and government institutions e.g. most countries have varying minimum rates of pay for employees and different tax systems. AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION - ASIC is the Australian government agency that enforces the Corporations Act 2001. - As an Australian registered company, M’s Australia Holdings Limited, which is 100% owned by M’s must report specific information to ASIC, including the company finances, the names and details of directors, the company share structure and resolutions. - Because of M’s size and the fact that it is foreign owned, the Corporations Act 2001 also compels M’s Australia to submit audited financial statements that can be publicly accessed. - ASIC heavily influences the way M’s conducts its affairs in Australia (due to enforcement of Corporations Act 2001) COMPANY TAXATION

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The 2016 Annual Report stated their effective rate of income tax on profit was 31.7%, globally. M’s has been subject to media reports that claim that it uses intercompany transfer payments to shift profit from Australia to countries that have low or 0 tax rates, however, M’s make no secret of this as the 2016 Annual Report stated the company’s tax rate is under the US tax rate (35%) as it uses global transfer pricing. Under Australian tax law, M’s Australia must pay income tax on profit made in Australia. During the 2015 Australian financial year, the ATO reported that M’s Australia had paid AU $127 million tax on its profit of AU $435 million. Global market influences – economic outlook, availability of funds, interest rates

THE GLOBAL MARKET ECONOMIC OUTLOOK - The 2016 Annual report states that M; s is a company impacted substantially by global economic fluctuations. - M’s has been viewed as “recession-proof” in developed economies, and often performs better during periods of economic downturn, due to the perceived value for money of its food. - However, when economic conditions are improving, consumers may spend their money elsewhere. - In developing economies however, where eating at M’s may be a luxury, sales may decline when economic conditions are bad. AVAILABILITY OF FUNDS - M’s has available a US $2.5 billion line of credit should it be required. - Low interest rates globally have ensured businesses like M’s have easy access to funds if needed, hence one of the factors as to why M is moving away from equity financing to debt. INTEREST RATES - Globally, interest rates are low, but in major markets like USA, Europe and Australia, interest rates have been predicted to grow modestly over the medium term. - M’s has fixed 82% of its total debt at an interest rate of 3.5% p.a., a reduction from 3.8% p.a. in 2015. - M’s takes loans in many countries it operates in. the interest rate it pays varies from 0.3% pa to 5.3% pa. As M’s has deliberately acquired more debt, interest payments for the business have risen in recent years. Processes of financial management –

Planning and implementing – financial needs, budgets, record systems, financial risks, financial controls FINANCIAL NEEDS:

– 2015, M’s identified the need to reimage some existing restaurants, modernising the exterior and interior to compete more effectively. The company budgeted this in its capital expenditure budget.

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Debt and equity financing – advantages and disadvantages of each – increased debt in recent years ADVANTAGES (debt): – debt can be incurred in various countries in which it operates- in the local currency, hedging foreign currency fluctuation risk (as at 31/12/2016, M’s held 34% of its long term debt in currencies other than US$. DISADVANTAGES (debt): the set nature of repayments: in terms of time frame and variable interest rates (however, M’s has negated much of this with financial risk strategies, including fixing 82% of total debt at an average of 3.5% p.a interest. ADVANTAGES: (equity) – M’s has paid increased dividends to shareholders every year for forty years as a result of its continued profitability. DISADVANTAGES: (equity) – The raising of more equity will dilute the stake of existing shareholders and is a slow, costly process.

– Matching the terms and source of finance to business purpose -

M’s leases most of the land and buildings on which franchisees run their business. The property is then provided to the franchisee for the running of the business. Under the franchise agreement, a franchisee agrees to pay M’s rent for the building for a 20-year period. Monitoring and controlling – cash flow statement, income statement, balance sheet

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Financial ratios-

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Liquidity -

The liquidity ratio decreased in 2017 to 0.44:1 from 0.49:1 in 2016, meaning Qantas is less able to meet its short term obligations.

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On the surface, Qantas’ low liquidity rate shows inability to meet its short term debts. However, like most other airlines it operates on a

negative working capital position. -

Qantas holds little cash reserves and uses the cash received to pay long term debt, thus reducing interest costs. Gearing

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Gearing ratio measures Qantas’ ability to continue its operations in

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the long term and is a measure of its financial stability. The gearing ratio has decreased from 136% in 2016 to 125% in 2017, meaning Qantas is more financially stable.  Profitability

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Profit performance is important to shareholders and long term creditors because in the long term Qantas must have a satisfactory level of profit to survive.

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Qantas net profit ratio (measures the proportion of each $ of sales that contribute to net profit) decreased from 9.5% in 2016 to 8.7%

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in 2017. The rate of return on owner’s equity (measures the return earned by management on the owners funds) also decreased from 47% in 2016 to 40% in 2017. Both these ratios show Qantas’ improved profitability since 2014.

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Profitability in the airline industry is poor on average. Qantas’ struggling international operations, high fuel prices and weaknesses in the domestic market pushed the airline into the red in 2014. Qantas reported a loss of $646 million.

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In 2016 Qantas’ profit had increased a further 57% posting a massive and record profitability of $1.53 billion. In 2017 Qantas backed this up with a $1.4 billion profit, confirming the success of Qantas’ recent financial strategies.

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Reducing its unit costs Qantas has become more competitive against its rivals. Efficiency

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Efficiency ratios measure Qantas’ ability to manage its assets in

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order to generate profits at minimum cost to the business. The total expense ratio measures total expenses as a proportion of total revenue increased from 90% in 2016 to 91% in 2017.

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The airline industry uses the revenue seat factor ratio (RSF) as a key

indicator of efficiency. It measures the % of total passenger capacity actually used by paying passengers. The RSF increased from 80% in -

2016 to 81% in 2017. Increased in the past years. An increasing RSF and a decreasing total expense ratio shows its financial strategies have been successful and the airline is using its assets more effectively, driven by the introduction of new and more efficient aircrafts and new IT systems.

 Growth -

In 2014, Qantas had to rein in costs and curtail its growth plans especially in Asia. Routes were cut and orders for new planes deferred.

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In recent years, Qantas has turned around its operations and is now expanding with new routes and increased capability largely in Asia.

 Solvency - Because of the capital intensive nature of the industry, airlines are highly geared. -

Qantas’ gearing increases rapidly in 2014 due to its falling profitability. The turnaround in profitability enabled Qantas to reduce its net debt by $1 billion in 2015, $750 million in 2016 and a further $434 million in 2017reducing its gearing and making the airline more financially stable, indicating the success of its financial strategies. Limitations of financial reports

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Qantas attaches comprehensive notes to its financial statements. These help stakeholders better understand the financial reports and give more clarity to their financial position.

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Special circumstances distort the analysis of results. E.g. in 2011 natural disasters and major weather events like Cyclone Yasi

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adversely affected Qantas’ profitability. Qantas’ financial reports don’t give a full picture of their debt as it does not disclose when these debts must be repaid.

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Hard to value their assets as they change over time. Ethical issues related to financial reports

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McDonald’s franchisees pay McDonald’s a % of gross sales for royalties and rent. This may incentivize individual franchisees to

make false financial statements and therefore reduce the fees payable to the head company. To prevent this, McDonald’s audits franchisees, as well as retaining access to each store’s computerized sales software. Financial management strategies - Working capital (liquidity) management - Current liquidity strategies employed by Qantas include:  Controlling current assets – cash, receivables, inventories  Controlling current liabilities – payables, interest bearing liabilities, and trade creditors  Strategies – leasing, sale and lease back - Leasing aircraft, buildings and plant. Leasing has freed cash that can be used elsewhere in the business. Debt market trends, tax depreciation and deterioration in aircraft residual rates have increased the attractiveness of leasing. - Qantas is one of the few airlines in the world to own its own terminals and has been considering selling and leasing back some of these assets. In 2016 Qantas sold Sydney Airport Terminal 3 for $185 million and leased it back. - Profitability management  Cost controls - Qantas has cut its costs by over $7 billion in the last 14 years, reducing its overall cost base by 20-25%. - Recent strategies employed by Qantas to control costs include: o Replacing Qantas with Jetstar on some international routes o Fuel hedging o Cutting commissions to travel agents o Entering into strategic alliances with other airlines (American Airlines)  Revenue controls - Total revenue in 2017 decreased by 1.8%. - Recent strategies employed by Qantas to control revenue include: o Setting clear sales objectives and setting up a sales reporting system that reports sales figures regularly and breaks them down into business segments. o Partnerships with Emirates and American Airlines expanding their international network o Improved marketing strategies like the new international business class, installing self service kiosks, new advertising campaign - Global financial management  Exchange rates - Qantas is exposed to various financial risks in its international business operations such as foreign exchange rates: constantly exposed to changes in exchange rates because purchases of jet fuel, operational expenditure like lease payments and interest

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repayments and capital expenditure such as buying new planes are denominated in foreign currency, mostly $US. Qantas estimates it generates 38% of its revenue in other currencies Changes in foreign exchange rates affect travel decisions by Australians.  Interest rates Qantas is exposed to movements in interest rates both in Australia and overseas. An increase in interest rates increase the interest payments Qantas pays on its borrowings.  Hedging Qantas uses many strategies to minimise the impact of financial risks to: o Reduce the probability of financial distress o Protect its capital base o Minimise the cost of capital Qantas has a successful hedging programme outperforming may of its airline peers. They have hedged 86% of its fuel needs for 2018. Most of these hedges are in the form of options, therefore Qantas is not locked in and can take advantage of any further falls in fuel prices.  Derivatives Uses forward cover and options to hedge future fuel purchases, future interest payments and future capital expenditure payments. Forward cover involves entering into a foreward foreign exchange contract to exchange one currency for another at a date in the future at a pre-determined exchange rate. Qantas earns revenue in many currencies and incurs costs like fuel, maintenance and leasing in other currencies. Swaps is another derivative used which involves foreign curren...