McDonald’s
November 2009
Price: $64
Research Report by
Peter Hughes, Check Capital Management
McDonald’s (MCD) is one of the
world’s
largest
restaurant
operators, with over 32,000
outlets. The company has annual
system wide sales and earnings of
$60 billion and $4 billion,
respectively. 64% of its sales and
52% of profits come from outside
the United States.
MCD's EPS & Dividends
$4.00
$3.50
$3.00
$2.50
$2.00
$1.50
$1.00
$0.50
The Business
$-
McDonald’s succeeds because it
offers consumers quick, tasty
EPS
Dividend
meals at low prices. Furthermore
its products are consistent from day to day across the entire globe. Two key factors in the
company’s success are its brand name and its operating excellence. In 2008 Business Week
ranked McDonald’s as the world’s eighth most valuable brand, estimating its value at over $31
billion. The firm enjoys economies-of-scale advantages over its rivals in marketing and
purchasing, helping it achieve superior returns. The average MCD restaurant in the U.S. had
sales of $2.0 million in 2007, versus $1.2 million at Burger King and $1.3 million at Wendy’s.
MCD has been fine-tuning its operations since Ray Kroc took over the company in 1955. The
firm began building drive-thru restaurants in 1975 and offering breakfast in 1977. More recent
changes include efforts to respond to changing consumer tastes by offering healthier menu items.
McDonald’s now sells grilled chicken items and several different kinds of premium salads.
Happy Meals can be purchased with apple slices and milk instead of fries and coke. Similarly,
MCD has added gourmet coffee to its menu. 6200 of the company’s 13,900 U.S. locations have
been refurbished in the last five years to give them a more casual, Starbucks-like feel. An
additional 2300 outlets will be “re-imaged” in 2010. Many restaurants offer Wi-Fi Internet
service to encourage people to spend time there. Besides updating existing restaurants, the
company is also opening some new outlets under the McCafe name, in an effort to create a
different feel from a traditional McDonald’s.
The firm’s restaurants can be found in all corners of the world. MCD has 18,000 outlets located
in 100 countries outside America. In most countries McDonald’s adapts it menu, mixing its
traditional burgers with local favorites to appeal to regional tastes. This gives the company many
avenues for experimenting with new products and achieving the best menu for each locale.
1
Check Capital Management Inc.

Costa Mesa, CA.

(714) 641-3579
(800) 710-5777
McDonald’s is focusing its growth on international markets. The company is opening 900 new
outlets in 2009 and plans to open 1000 in 2010, and over 80% of these will be located outside the
U.S. Although opening restaurants in new markets is expensive, returns improve as costs are
spread across a growing number of outlets. MCD achieves an operating margin of 40.6% in the
U.S., versus 27.9% in Europe and 22.6% in its other international markets. Over time it is likely
the operating margin abroad will move towards that of the U.S. Furthermore, while the core
U.S. market is mostly saturated, foreign countries provide MCD much greater growth
opportunities. Not only are there fewer fast-food alternatives, but burgeoning middle-classes in
many developing countries see MCD’s products as an affordable luxury. This suggests the firm
still has significant growth potential and will continue to benefit from long-term demographic
trends.
Management is attempting to increase the firm’s returns in several ways. One strategy is to sell
many company-owned outlets to franchisers. This action allows the firm to focus more on
marketing and product development and less on
SG&A Expense as a Percent of Sales
operating individual stores. The company has
13.0%
sold off over 1000 restaurants since 2007 and
12.0%
currently owns only 12% of all McDonald’s
11.0%
outlets. By selling to franchisors the company
10.0%
reduces its sales but also lowers its capital
9.0%
requirements. The net effect is generally higher
8.0%
returns-on-capital. In foreign countries, the
7.0%
strategy of partnering with local franchisors also
6.0%
helps MCD to make allies in markets that might
2004
2005
2006
2007
2008
2009*
otherwise be less friendly. Management has
also made an effort to cut costs. As the graph at right shows, selling, general, and administrative
expenses as a percent of sales have steadily declined over the last five years.
These falling costs closely correspond to MCD’s strong earnings growth in recent years. The
company’s current results are solid, but have been masked by a higher U.S. dollar, which makes
overseas results appear weaker. In Q3, EPS rose 10% but would have grown 14% if foreign
exchange rates hadn’t been working against the firm. The dollar is now declining versus foreign
currencies, so MCD’s results should benefit in coming quarters. The company is also benefiting
as many consumers trade down to MCD’s affordable offerings. Same-store-sales are increasing
about 4% per month, faster than at most other restaurants. Earnings-per-share will likely
increase 8% in 2009.
Financial Metrics
MCD’s business strengths enable the firm to achieve strong financial metrics. The company
produces a net profit margin and return-on-capital both approa-ching 20%. Furthermore MCD
produces a great deal of excess cash and uses this money to reward shareholders. From 2006 to
2008 the company generated $15.1 billion in cash from operations and returned $13.0 billion to
2
Check Capital Management Inc.

Costa Mesa, CA.

(714) 641-3579
(800) 710-5777
shareholders in dividends and share buybacks. The firm has raised the dividend for 33
consecutive years, and MCD stock now yields 3.5%. Management has retired 13% of the shares
since 2004, including $2.2
McDonald's Financial Metrics
billion repurchased in the first
20%
three quarters of 2009. The firm
has
achieved
this
while
15%
employing a moderate level of
debt.
10%
Valuation
5%
Because of its global market
0%
position and strong financial
1999
metrics,
McDonald’s
has
frequently traded at a premium
valuation. However, in the past
year the stock has fallen to one of its lowest
valuation levels of the last two decades. The
stock has now recovered somewhat from its
low and trades at a valuation of 16 times
earnings.
Given the strength of the company’s
business, strong cashflow and dividend yield,
the current stock price appears to offer
investors a good entry point and the potential
for good long-term investment returns.
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009*
Return on Capital
Net Profit Margin
$80
Price
$60
16 Times Earnings Per Share
$40
$20
$0
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
35
P/E Ratio
30
25
20
15
10
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
CCM Research Reports are for informational purposes only and are not an offer to sell or a solicitation to buy.
They are not personal recommendations for any particular investor and do not take into account the financial
circumstances of any individual investor. Check Capital, or one of its officers, may have a position in the securities
discussed and may purchase or sell such securities from time to time. CCM Research Reports are created using
third-party data. While Check Capital believes such third-party information is reliable, we do not guarantee its
accuracy, timeliness or completeness.
3
Check Capital Management Inc.

Costa Mesa, CA.

(714) 641-3579
(800) 710-5777