Does McDonald's really deserve AA bond rating?


July 15, 1991|By Herb Greenberg | Herb Greenberg,Chronicle Features

New York analyst Bob Renck, who runs an independent research company, thinks that debt-rating agencies are too soft on McDonald's Corp. Renck, whose R.L. Renck & Co. turned bearish on the fast-food giant a year ago, is back with a new report arguing that the company deserves a lowly Triple-B rating -- just one notch above junk -- rather than its current, respectable Double-A status. (The lower the debt rating, the higher a company's borrowing costs.)

Renck, whose clients are professional money managers, bases his opinion on the guidelines set by Standard & Poor's, the largest debt rater. S&P established certain financial ratios that it thinks companies should achieve, and McDonald's exceeds the standard in only one case: operating income-to-sales, Renck claims. He adds that in the two categories that S&P considers to be the key measures of financial risk -- debt-to-capitalization and cash flow-to-operations -- McDonald's is a laggard.

Renck goes on to say what other critics have been saying lately -- that McDonald's is no longer the growth company it's cracked up to be. He notes that it doesn't generate positive cash flow -- and hasn't since it went public decades ago.

S&P doesn't dispute most of Renck's findings. But Jerry Hirshberg, a veteran fast-food watcher for S&P, says that his firm's ratings guidelines are just that -- guidelines, not requirements. He says, for example, that he's not surprised that a company that has grown as fast as McDonald's would eat up its cash to expand its operations. "Numbers can tell a lot of different stories," he says. "But everything is subject to interpretation, and a good deal of subjective analysis." His subjective analysis is that McDonald's remains strong.

Hirshberg adds that he believes McDonald's earnings are capable of growing at 10 percent to 20 percent per year, in part because of the huge potential for international growth.

But Renck, who was early to spot problems last year at Marriott Corp., doesn't agree. "The belief that McDonald's is both a Double-A credit and an excellent business opportunity for a prospective franchisee may be based more on perceptions than on reality," he says.

I was unable to reach McDonald's officials.

Short Positions

* Big Blue blues: Morgan Stanley analyst Andrew Kessler thinks that by the end of 1991 IBM will announce 50,000 layoffs and several plant closings, and that it will take write-offs of at least $1 billion. He also thinks that the company will slash prices on everything but service, where demand is constant. But if any of this does indeed happen, it may not help in the end, he says. He thinks the winners among computer companies are likely to be those like Sun Microsystems or AST Research "that have already set up their corporate structure to handle lower margins."

* Debt-heavy: Salomon Brothers banking analyst Tom Hanley contends in a just-published report that the trouble with leveraged-buyout loans isn't over yet. Since March 1990, non-performing leveraged-buyout loans have surged 126 percent at the 35 banks he follows. Regulators evidently forced Wells Fargo to acknowledge LBO-loan problems, and there may soon be many other "unpleasant surprises" involving major banks, Hanley says.

* Whither rates?: Rick Holbrook, a strategist for the San Mateo, Calif., investment-advisory firm of Bailard Biehl & Kaiser, believes that interest rates on 30-year Treasuries -- now at about 8.5 percent -- could fall to as low as 7.75 percent by year end. He thinks the fall will be triggered by sliding rates worldwide. But as any casual reader of the business press knows, economists are split over the expected direction of rates. (Aren't they always?) Which prompts one to ask about Holbrook's performance in calling interest-rate fluctuations. "We all have mixed records," he concedes.

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