McDonald’s Corporation
April Hahnfeld
Analyst
July 18, 2010
Recommendation:
HOLD
Porter’s 5 Forces:
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•
•
•
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Threat of Competition: High
Threat of New Entrants: High
Threat of Substitution: Low-Moderate
Power of Suppliers: Low
Power of Buyers: Low
Pros:
Ticker
MCD
Exchange
NYSE
Industry
Retailing - Foods
Sector
Consumer Services
Classification
Income &
Capital Appreciation
Market Cap.
$71,153 M
52 Week Price range
$53.88 - $71.84
Recent Price
$69.22 (7/9/2010)
Current P/E
15.59
Projected 2012 P/E
14.27
2009 EPS
$3.98
Projected 2012 EPS
$
Dividend Yield
3.33%
Debt Rating
AA-
Beta
0.61
•
•
•
•
•
Best profit margin in the industry
Moderate Leverage
Good dividend yield and earnings growth
Attractive per-share earnings growth due to large
share repurchases
Significant internal exposure and shareholder focus
Cons:
•
•
•
•
Commodity cost risks
Extremely competitive industry
High food, energy, and labor cost concerns
Product failures
Brief Overview
McDonald’s Corporation’s principal activity is to franchise
and operate McDonald’s restaurants in the food service
industry. These restaurants serve a varied, yet limited, valuepriced menu in more than 100 countries worldwide. All
restaurants are operated either by the Company or by
franchisees, including conventional franchisees under
franchise arrangements, and foreign-affiliated markets and
developmental licensees under license agreements.
Independently-owned and operated distribution centers,
approved by the Company, distribute products and supplies to
most McDonald’s restaurants.
In addition, restaurant
personnel are trained in the storage, handling and preparation
of products and in the delivery of customer service. In
February 2009, the Group sold its interest in Redbox
Automated
Retail,
LLC. 1
1
Thomson One
PORTFOLIO CONSIDERATIONS
The EIF currently has 3.64% of equity assets invested in McDonald’s. The stock falls within the Retailing-Food
industry of the Consumer Discretionary sector and is classified as an Income & Capital Appreciation stock with
a dividend yield of 3.3%. MCD accounts for 37.7% of Consumer Discretionary holdings.
The sector comprises 10.96% of the S&P 500 Index and the EIF has a 7% target weighting for summer 2010.
The EIF is currently 3.37% underweight the summer 2010 Income & Capital Appreciation target weighting of
30%.
INDUSTRY OVERVIEW
CURRENT INDUSTRY OUTLOOK
Over the five years to 2015, industry revenue is expected to increase at an average rate of 2.5%. The industry
will show its first signs of growth in 2010, and then the industry will resume its long term growth trend from
2011 onward. Aggressive competition is likely to continue over the next five years. This will involve
significant price-based competition; and increasing emphasis on the regular introduction of new products,
including healthy-eating ones; and a move away from standard products by allowing some menu and meal
choices by customers. Most fast food chains will introduce new healthy food alternatives and expand their
current product line. They are also diversifying into areas, such as cafes and full service restaurants, but
operating under different brands, through multi-branding concepts at both existing and new locations.
Many domestic operators will continue to seek international expansion opportunities. International expansion is
expected to be the largest source of revenue and profit growth for major players over the next five years.
Consolidation among operators has been occurring for some time and is expected to continue, though new
growth opportunities will offset those losses. Over the next five years, the number of establishments is
expected to increase. Over the same period, industry employment is projected to grow and will be partially
inflated by the increasing use of casual employees to meet peak customer service periods. Over the next five
years, there is expected to only be a marginal improvement in industry profitability due to the on-going
significant level of competition in the low growth, saturated domestic market.
RESTAURANT OUTLOOK
After the recent recession hit the hotel and restaurant sector, this year will show and improvement in demand.
The long-term growth prospects for restaurants are more optimistic due to a consistent demand growth trend.
Demand in the food services industry should improve over the near term. Consumer spending on food away
from home increases 2.2% in 2010 and 5.2% in 2011, after a decline of 1.9% in 2009. While growth will be
tepid at first, we expect a strong resurgence through the end of 2010 and into 2011. This mirrors the trend in
real consumer spending on all goods and services, with spending at restaurants slightly more pro-cyclical than
overall spending.
CURRENT PERFORMANCE
Over the past few years the fast food industry has been battered by a weakened economy, the rapid rise in
unemployment, as well as society’s increasing awareness of the health risks associated with a high fat, salt and
sugar diet. Despite these obstacles, the industry has made strides to ensure it quickly responds to changes in
consumer preferences. Over the five years to 2010 industry revenue is expected to grow at an average annual
rate of 0.4% per year. Industry revenue declined 3.3% in 2009, though it is expected to partially bounce back in
2010 with revenue increasing 3.0%.
The general economic malaise and rising unemployment rates have resulted in household disposable income
levels declining over the last few years. The average consumer is spending less on luxuries like eating out and
when they do they tend to purchase lower priced items. This has forced fast food chains to compete with each
other to convey to consumers that their restaurants are where you can get the most bang for your buck. The
competition between operators has now become more intense, with a shift more toward taking market share
from each other, rather than seeking a share of a growing market. Some revenue is also lost in the form of
substitute completion, with certain consumers cutting out fast food altogether and instead saving money by
cooking themselves.
Consumers are becoming increasingly health conscious and major fast food retailers have responded by
expanding the number of healthy options on their menus. For many fast food chains this has become a
cornerstone of their marketing strategy and has enabled them to target a new segment of the market and renew
interest in their products. Although it has cooled to a certain extent with the onset of the recession, international
growth is still a large part of many major chains long term strategy. China, in particular, is viewed by fast food
restaurants as a market that has huge potential for growth and long term profitability.
INDUSTRY PERFORMANCE
Due to the changing economic conditions and consumer tastes as described above, total revenue from the fast
food industry is expected to increase by only .04% per year over the five years ending in 2010. The industry
experienced two distinct growth and decline periods during the last five years, with the industry riding on the
coattails of expanding economy in the first half and fighting through the declining demand in the second part.
From 2005 through 2006, industry revenue was driven by strong economic growth. Industry revenue grew
4.9% to $180.6 billion 2005 and 5% to $189.5 billion in 2006, though there were indicators of the troubles
around the corner. Operators competed ferociously in the domestic market and some further consolidation of
underperforming sites occurred, as operators searched for better located and higher volume ones. Many
launched new concepts and menus (that included more healthy items) and expanded internationally in order to
grow overall revenue and profits.
In 2008 and 2009, lower levels of consumer expenditure resulted in people cutting their fast food spending.
Rising unemployment also contributed to lower demand. This combined with an increased focus on healthy
eating seemed to secure the industry’s fate. In 2008, industry revenue declined 0.9% to $184.8 billion.
Revenue is forecast to fall an additional 3.3% to $178.6 billion in 2009. In 2008, the industry was also directly
affected by increased commodity and food prices that led to reducing margins or to untimely menu price rises,
as store traffic declined. Fast-food meals are typically viewed by many as an area where potential expenditure
savings can be made. Increasingly, priced-based competition value-added meal offerings and discounts spread.
Consolidation of menus and underperforming sites occurred, as well as expansion plans, as the recession spread
globally. In 2009, major players continued to consolidate some underperforming revenue and profit growth
occurred form their expansion into China and other countries.
The industry is expected to turn the corner in 2010, with revenue growing 3.0% to $184.0 billion. Industry
profit margins have been declining (and remaining flat at best) due to lower sales volume and customers opting
for lower priced items (thereby reducing revenue), high levels of competition in the domestic market, and with
the industry reaching saturation levels.
2
COMPANY OVERVIEW
HISTORY 3
MCD’s business began in 1940, with a restaurant opened by brothers Richard and Maurice McDonald in San
Bernardino, California. Their introduction of the "Speedee Service System" in 1948 established the principles
of the modern fast-food restaurant. The original mascot of McDonald's was a man with a chef's hat on top of a
hamburger shaped head whose name was "Speedee." Speedee was eventually replaced with Ronald McDonald
by 1967 when the company first filed a U.S. trademark on a clown shaped man having a puffed out costume
legs.
McDonald's first filed for a U.S. trademark on the name McDonald's on May 4, 1961, with the description
"Drive-In Restaurant Services," which continues to be renewed through the end of December 2009. In the same
year, on September 13, 1961, the company filed a logo trademark on an overlapping, double arched "M"
symbol. The overlapping double arched "M" symbol logo was temporarily disfavored by September 6, 1962,
when a trademark was filed for a single arch, shaped over many of the early McDonald's restaurants in the early
years. The modern double arched "M" symbol that continues to be in use today at McDonald's restaurants did
not appear until November 18, 1968, when the company filed a U.S. trademark on the now famous symbol that
continues to be in use through the end of the year 2009.
The first McDonald's restaurants opened in the United States, Canada, Costa Rica, Panama, Japan, the
Netherlands, Germany, Australia, France, El Salvador and Sweden, in order of openings.
The present corporation dates its founding to the opening of a franchised restaurant by Ray Kroc, in Des
Plaines, Illinois, on April 15, 1955, the ninth McDonald's restaurant overall. Kroc later purchased the
McDonald brothers' equity in the company and led its worldwide expansion, and the company became listed on
the public stock markets in 1965. Kroc was also noted for aggressive business practices, compelling the
McDonald brothers to leave the fast food industry. The McDonald brothers and Kroc feuded over control of the
business, as documented in both Kroc's autobiography and in the McDonald brothers' autobiography. The site of
the McDonald brothers' original restaurant is now a monument.
3
Wikipedia
With the expansion of McDonald's into many international markets, the company has become a symbol of
globalization and the spread of the American way of life. Its prominence has also made it a frequent topic of
public debates about obesity, corporate ethics and consumer responsibility.
MCD now employs over 400,000 people worldwide. Their revenue is more than Subway and Yum! Brands
combined. They have restaurants all throughout North and South America, Europe, Australia and Asia, but are
only thinly available in the Middle East and Africa. The primary food products they serve are hamburgers,
cheeseburgers, chicken meals, French fries, coffee and milkshakes, but are beginning to offer healthier products
like wraps and salads.
McDonald’s serves 58 million customers each day. That’s approximately the population of Italy, and larger
than the population of South Korea. McDonald’s sells it products in 118 countries and operates over 21,000
restaurants. Approximately 80% are franchisee operated and the rest are operated by the corporation.
INVESTMENT THESIS
MCD has been selling various investments in order to focus on the McDonald’s brand. They performed an
initial public offering of Chipolte Mexican Grill in 2006, sold Boston Market in 2007, and sold Pret A Manger
in 2008.
Although everyone knows McDonald’s is international, most consider it a predominately American
establishment. However, McDonald’s takes in more revenue from Europe than from North America. MCD
generates over $8 billion in revenue from North America, nearly $10 billion from Europe, and over 44 billion
from APMEA (Asia-Pacific, Middle East, and Africa). Sales growth in North America has been less
impressive, though positive, as compared to sales growth in Europe and especially APMEA.
MCD has been more focused on real estate than restaurants dating back to when Ray Kroc ran the company.
MCD typically owns or has long-term leases for the restaurants they and their franchisees operate. The
company operates both franchisee and corporate-owned restaurants. The franchisee owned restaurants have
high profit margins, with MCD collecting rent and royalties, but the corporate owned entities all MCD to
develop new products and new looks and keeps management fresh and knowledgeable.
MCD has always been focused on quantity over quality. They sell inexpensive, tasty food to several million
people per day. In the past few years, however, MCD has acknowledged their shortcomings and have been
focusing on quality over quantity. They have remodeled their stores worldwide to include softer colors and
more wood to replace the old red and yellow plastic look of yesterday. They have also launched their McCafe
brand which is basically their own coffee shop, and it has grown at an excellent rate.
SHAREHOLDER FOCUS
When it comes to focusing on the shareholder, few do it better than MCD. Almost all of their income flows
directly to shareholders in the form of dividends and share repurchases, yet they still grow earnings and raise
dividends each year. The company has a policy in which all leaders have to own a significant amount of
MCD’s stock and hold onto it during their tenure. The CEO must own at least 6x his annual base salary worth
of MCD’s stock. The President and the Board of Directors must all own at least 5x their annual salary. District
presidents, executive vice presidents, and senior vice presidents must own between 2 and 4x their base salaries.
This keeps leaders in line with shareholders because they themselves are significant long-term shareholders. 4
4
Dividend Monk
COMPANY OUTLOOK
MCD will continue to focus on their “better, not just bigger” strategy and the key drivers of exceptional
customer experiences – People, Products, Place, Price and Promotion. Their global System is energized by their
ongoing momentum, strong competitive position and growth opportunities. MCD intends to further differentiate
their brand, increase customer visits and grow market share by pursuing initiatives in three key areas: service
enhancement, restaurant reimaging and menu innovation.
SHARE REPURCHASES
From 2007 to 2009, MCD has returned $16.6 billion to shareholders through share repurchases and dividends,
compared to a market cap of $72 billion. This amount represented a doubling of the $8.3 billion returned to
shareholders during the previous three-year period. Even after accounting for their small annual issuance of
stock, this is still significantly more than they’ve paid in dividends over those same three years. From this it can
be shown that almost all income from McDonald’s goes back to shareholders.
STRATEGY 5
MCD’s Plan to Win strategy is a multifaceted approach to increase sales and profitability at existing locations.
Key tenets of this plan include increased menu variety and beverage choices, improved restaurant operations,
added convenience and extended hours, maintaining everyday affordability, and continued restaurant
reinvestment. Financial objectives include annual systemwide sales growth of 3%-5%, average annual operating
income growth of 6%-7%, and annual returns on incremental invested capital in the high teens.
ANALYSIS 6
MCD got off to a strong start in 2010 with a solid recovery in U.S. comparable sales growth, sustained
momentum in international sales growth, and impressive operating margin gains in its first quarter. Analyst
remain confident that MCD’s competitive advantages, including a universally known brand and unparalleled
scale advantages, position the firm to thrive under any economic environment.
After posting flattish U.S. comparable sales in January and February, MCD came back strong in March with
4.2% growth, thanks to a general increase in consumer optimism as well as menu innovations such as frappes,
value-priced beverages, and the breakfast dollar menu. Analysts continue to anticipate low- to mid-single-digit
comparable sales growth in the U.S. during 2010. There were also several reasons for optimism in Europe, as
MCD continued to outperform other quick-service restaurant chains across the Continent, including key markets
such as France, Russia, and the United Kingdom. Asia/Pacific, Middle East, and Africa results were also
encouraging, including further improvement in China comparable sales trends. There is no change to analysts’
full-year expectations of mid-single-digit comparable sales growth in MCD’s international segments.
The 220-basis-point increase in consolidated operating margins to 29.8% was the highlight of the quarter, very
likely due to favorable food and paper commodity prices. Although commodity prices are expected to rise
during the second half of the year, the firm will offset most of these pressures through diligent management of
labor and other operating expenses. Analysts continue to project modest operating margin gains in 2010.
MCD continues to thrive despite an increasingly challenging environment for restaurant operators. Although it
is doubtful they can duplicate the 1,000 basis points of operating margin expansion it posted over the past five
years, it is highly likely that MCD is capable of generating excellent returns on invested capital over an
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Morning Star
Morning Star
extended horizon. This likelihood stems from unrivaled scale advantages, an incredibly strong brand, and
ample international growth opportunities. These advantages are extremely unlikely to decrease anytime soon,
thus earning MCD the widest economic moat in the restaurant category.
With average annual sales of over $2.2 million per restaurant, MCD’s restaurant productivity easily trumps the
quick-service restaurant industry average of just over $1 million per location. This outperformance can be
attributed to a number of factors, including brand strength, convenient restaurant locations, and a consistent
customer experience across the globe. Product innovation has also played a role driver of MCD’s productivity.
Over the past several years, the company has introduced a number of new margin-accretive products such as
snack wraps, Southern-style chicken products, and Angus beef burgers. They have also developed strong
beverage initiatives, including the McCafe specialty coffee menu and real fruit smoothies, which launched
nationwide this summer. Exterior and interior restaurant décor upgrades, more efficient kitchens and drivethrus, and free wireless Internet access also keep MCD ahead of the competition and help to attract incremental
customer traffic.
MCD has one of the strongest brands in the world, aided by an unrivaled advertising budget of more than $650
million. Another underlying strength is MCD’s cohesive franchisee and affiliate system, which collectively
operate 80% of the chain. This structure provides the firm an annuity-like stream of rent and royalties, even
during challenging economic times, with minimal corresponding capital needs. AS a result, MCD generates
excellent free cash flow and returns on invested capital in mid teens to high teens. These results are even more
impressive when considering that the firm owns 45% of the land for its restaurants ($5 billion in land assets),
meaning that the returns are generated on a higher invested capital base than most franchised restaurant chains.
Despite its competitive advantages, even the best-operated restaurant chains are susceptible to cyclical
headwinds, including high unemployment rates and volatile commodity, labor, and occupancy costs. MCD also
faces broad competition from a number of global quick-service restaurant chains, including Burger King, and
YUM! Brands. However MCD is fully expected to weather economic pressures more effectively than their
competition due to the existing gap in economic performance.
PORTER’S FIVE FORCES
Threat of Competition: HIGH
While there are a number of fast-food restaurants in business right now, McDonald’s is by far the largest. The
competition is mainly from large corporations that run a number of locations and brands. These large firms are
able to back up their positions with a high level of marketing. The most popular fast food is the ready prepared
sandwich market, which account for about a third of the market. This is followed by the burger market, where
McDonalds and Burger King dominate with 91% of the market. Next is the fish and chip sector which is half
the size of the burger sector and made up of many independent shops. McDonalds has the cost advantage and
appear to try to compete on differentiation. A key success factor in the rivalry of this industry is the locations of
the fast food outlets. So while in the industry there is a high level of threat, MCD’s rivals do not pose enough
of a threat to its wide economic moat.
Threat of New Entrants: HIGH
There are very few significant barriers to entry in the fast food industry. The main one being the local
authority’s regulation of limiting the number of new outlets of a particular type that can open in a given
geographical location. Also, while new entrants may not be able to gain the cost advantage in the short term,
there are few barriers to entry and consumer loyalty is low in this market. The access to the market is easy and
it has been shown that as a mature market, the fast food restaurants that one will often find that potential
customers are very keen to try new offerings. There may also be difficulties in getting some prime high street
locations; it has been known for some fast food chains to sign or buy leases simply to prevent a rival from
getting into a location, a strategy used by Starbucks for example. The start-up costs are relatively low, and there
have been many new entrants in recent years, companies such as Subways have entered and expanded their
presence demonstrating the ease that new firms can enter. Therefore, new entrants are a serious threat, and
more serious to smaller firms that do not have the advantage of extensive marketing support, a problem MCD
does not have.
Threat of Substitutes: LOW-MODERATE
There are competitors to this industry, apart from continuing strong competition within the industry itself,
operators from other food service providers, including full service restaurants, caterers and pre-prepared foods
available from supermarkets, are also seeking their fair share of household expenditure on meals. 7
Power of Suppliers: LOW
As the world’s largest restaurant chain in terms of systemwide sales, MCD wields tremendous economies of
scale relative to its quick-service restaurant peers. MCD can exert a significant amount of bargaining power
over its suppliers, many of whom owe their existence to MCD in the first place, thus ensuring access to food
and other raw materials at predictable, competitive prices. 8
Power of Buyers: LOW
The power of buyers in the fast food industry is low.
COMPETITORS
BURGER KING HOLDINGS, INC.
Burger King Holdings, Inc. is a fast food hamburger restaurant. As of June 30, 2009, BKC owned or franchised
a total of 11,925 restaurants in 73 countries and United States territories, of which 1,429 restaurants were
Company restaurants and 10,496 were owned by its franchisees. Of these restaurants, 61% were located in the
United States and 39% were located in it international markets. BKC’s restaurants feature flame-broiled
hamburgers, chicken and other specialty sandwiches, French fries, soft drinks and other food items. BKC
generates revenues from three sources, retail sales at Company restaurants; franchise revenues, consisting of
royalties based on a percentage of sales reported by franchise restaurants and franchise fees paid to it by its
franchisees, and property income from restaurants BKC leases or subleases to franchisees. Burger King
operates in three reportable segments; the United States and Canada, Europe, the Middle East, Africa and Asia
Pacific (EMEA/APAC), and Latin America.
YUM! BRANDS, INC.
YUM was founded in 1997 and is headquartered in Louisville, Kentucky. YUM operates independently of
Pepsico, Inc. as of October 6, 1997. YUM! Brands, Inc., together with it subsidiaries, operates as a quick
service restaurant company worldwide. The company develops, operates, franchises, and licenses a system of
restaurants, which prepare, package, and sell various food items. Its restaurants specialize in chicken, pizza,
Mexican-style food, and quick-service seafood categories. As of December 26, 2009, it operated approximately
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IBIS World
Morning Star
37,000 restaurants in 110 countries and territories under the KFC, Pizza Hut, Taco Bell, Long John Silver’s, and
A&W All=American Food Restaurants brands. The company was formerly known as TRICON Global
Restaurants, Inc. and changed its name to YUM! Brands, Inc. in May 2002. YUM is highly leveraged with a
LT debt to equity ratio of 3.13. As compared with MCD’s 0.75, Yum! Has far less freedom to for expansion in
the future. 9
CRITICAL ISSUES
ATTITUDE CHANGES – HEALTH CONSCIOUSNESS
There is increasing consumer awareness of issues related to weight and obesity, fatty food intake and food
safety issues, which are impacting on this industry’s growth, particularly for meat and hamburger producs and
any fried products. The currently observed trends toward greater health consciousness are forecasted to
continue into the future as greater public attention is paid toward the various problems and as the effects of less
healthy lifestyles become more apparent.
BARRIERS TO FUTURE INDUSTRY GROWTH
The barriers to future industry growth are now largely due to total market saturation and by changes in the age
structure of the population, a leaning towards healthy diets and some competition for both labor and store sites.
There have been some concerns about mad cow disease among consumers for certain meat quick service
products and many have diversified into chicken and other products, including Italian- and Mexican-style foods.
Some major operators have begun developing combined or multi-branded outlets in which they share these
locations with their own brands or food styles. 10
ENVIRONMENTAL MATTERS
Increased focus by U.S. and overseas governmental authorities on environmental initiatives, particularly in the
area of climate change. While the precise nature of these initiatives cannot be predicted, MCD expects that they
may impact their business both directly and indirectly. Although the impact would likely vary by world region
and/or market, MCD believes that adopting new regulations may increase costs, including for themselves, its
franchisees and suppliers. Also, there is a possibility that governmental initiatives, or actual or perceived
effects of changes in weather patterns or climate, could have a direct impact on the operations of MCD’s
restaurants or the operations of their suppliers in ways which cannot be predicted at this time.
MCD continually monitors developments related to environmental matters and plans to respond to
governmental initiatives in a timely and appropriate manner. At this time, MCD has already undertaken its own
initiatives relating to preservation of the environment, including the development of means of monitoring and
reducing energy use, in many of its markets. 11
INCREASING REGULATORY COMPLEXITY
The legal and regulatory environment worldwide exposes MCD to complex compliance, litigation and similar
risks that affect their operations and results in material ways. In many of their markets, including the U.S. and
Europe, MCD is subject to increasing regulation, which has increased their cost of doing business. In
developing markets, MCD faces the risks associated with new and untested laws and judicial systems. Among
more important regulatory and litigation risks, there are additional issues that must be managed. For example,
the cost, compliance and other risks associated with the often conflicting regulations MCD faces, especially in
9
Yahoo Finance
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MCD 2009 Annual Report
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the U.S., where inconsistent standards imposed by local, state and federal authorities can adversely affect
popular perceptions of their business as well as increase their exposure to litigation or governmental
investigations or proceedings. These new, potential or changing regulations can also impact or restrict elements
of MCD’s business, particularly those relating to advertising to children, nutritional content and product
labeling and safety. 12
RECOMMENDATION
HOLD
PROS TO RECOMMENDATION
•
•
•
•
•
•
Best profit margin in the industry
Moderate Leverage
Good dividend yield
Good earnings growth
Attractive per-share earnings growth due to large share repurchases
Significant internal exposure and shareholder focus
In addition to these pros, MCD maintains the leading market position in virtually every country in which it
operate, and there are still existing global expansion opportunities. MCD has worked diligently to reinvigorated
their brand and elevate the customer experience through engaging marketing campaigns, extended hours, free
wireless Internet access, and renovated restaurants, leading to increased restaurant traffic. MCD’s new
premium product launches, such as the Angus Third Pounder hamburger and the McCafe specialty coffee menu,
have been incredibly well received. Some analyst project that MCD could evolve into Starbucks’ fiercest rival
in the specialty coffee segment. MCD produces stable cash flow, even in challenging economic times, because
of long-term franchisee royalty and rent payments. The company owns 45% of the land and about 70% of the
buildings for its restaurants, as of year-end 2009. And last, MCD has a 30-year-plus history of paying cash
dividends and repurchasing shares, including $5.0 billion returned to shareholders in 2009. 13
CONS TO RECOMMENDATION
•
•
•
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Commodity cost risks
Extremely competitive industry
High food, energy, and labor cost concerns
Product failures
Volatile commodity costs, foreign currency headwinds, and difficult year-over-year comparisons could disrupt
MCD’s short-term results. Additionally, the quick-service restaurant industry is fiercely competitive, marked
by a history of price wars where switching costs are virtually nonexistent. Bankruptcies among quick-service
franchisees are on the rise, and tighter credit markets could constrain small franchisee growth. Many of MCD’s
rivals, including Burger King and Jack in the Box, aggressively target heavy fast-food eaters with indulgent
items, MCD, being the largest player in the industry, often receives the blame for rising obesity problems.
Though the largest, MCD has not been immune to product failures, including the Arch Deluxe, the McLean
1212
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MCD 2009 Annual Report
Morning Star
Deluxe and McPizza. 14 As MCD attempts to further expand the quality of the product offerings, these risks will
continue.
ANALYST RECOMMENDATIONS
Current consensus amongst analysts has been averaged a moderate buy recommendation for MCD. There are
no sell recommendations and a number of strong buys currently as well as within the past quarter.
CONCLUSION
McDonald’s has been growing at a market-beating rate for years. Lately revenue has been a bit stagnant, but
this is due to the economy and will likely improve as the economy improves. So far 2010 has been a strong one
for MCD, and I believe they will continue to persevere through the economic downturn.
RATIO ANALYSIS
Ratio Analysis
Valuation
Price: Earnings
Price:Cash Flow
Price: Sales
Price:Book
Financial Strength
Quick Ratio
Current Ratio
LT Debt to Equity
Return on Equity
Return on Assets
Return on Invested
Capital
14
Morning Star
MCD
BKC
YUM
Industry
S&P
500
2008
2009
TTM
TTM
TTM
TTM
16.50
12.00
3.00
5.20
15.20
12.00
3.00
4.80
15.60
12.69
3.08
4.91
11.65
6.67
1.15
2.07
16.97
12.71
1.62
15.56
17.35
11.47
0.40
5.60
18.46
9.78
0.44
3.25
0.96
1.14
75.27
33.20
15.51
(MRQ)
0.96
1.14
75.25
33.16
16.84
20.16
(MRQ)
0.60
0.77
84.26
20.55
8.80
12.98
(MRQ)
0.46
0.73
309.37
226.41
18.42
30.90
(MRQ)
1.20
1.09
148.25
1.00
12.81
17.88
(MRQ)
1.20
1.88
63.84
1.00
7.61
12.97
1.18
1.39
76.16
30.10
16.17
Debt Utilization
Debt:Equity
Financial Leverage
0.76
2.13
0.75
2.15
0.74
2.11
0.68
2.46
3.09
6.85
1.12
2.3
1.13
3.8
Assets
Asset Turnover
Inventory Turnover
0.81
125.70
0.78
128.18
0.77
72.83
0.94
100.86
1.57
18.29
1.20
53.59
0.79
12.36
Profitability
EBITDA
Operating Margin
Net Profit Margin
Gross Profit Margin
$7.89B
27.40%
18.30%
36.70%
$8.18B
30.10%
20%
34.70%
$6.8B
28.80%
20.00%
59.80%
$342.1M
13.60%
7.90%
32.90%
$1.5B
14.70%
9.90%
72.30%
$1.5B
19.90%
12.80%
43.40%
$3.0B
17.00%
10.60%
43.80%
DuPont Analysis:
Net Profit Margin
Asset Turnover
Financial Leverage
Return on Equity
18.30%
0.81
2.13
31.57%
20.00%
0.78
2.15
33.54%
20.00%
0.77
2.11
32.49%
7.90%
0.94
2.46
18.27%
9.90%
1.57
6.85
106.47%
12.80%
1.20
2.30
35.33%
10.60%
0.79
3.80
31.82%
PROFITABILITY
Although MCD is not expected to duplicate the impressive margin expansion it has delievered over the past
several years, the company is fully capable of modest gains as international markets develop scale. Over the
next three years, analysts project MCD’s average annual operating margins of 30.6%.
FINANCIAL HEALTH
MCD is in excellent financial health. Debt/capital is about 0.43, EBITDA covers interest 17 times, and its Cash
Flow Cushion (cash on the BS and future cash flow divided by debt and other debt –like commitments) is about
2 times. Although unlikely, MCD could support incremental debt due to leverageable assets on its balance
sheet and a strong free cash flow profile. Analysts currently give MCD an issue credit rating of AA-.
PROFORMA ASSUMPTIONS
Revenues:
I used estimates from a Bank of America Merrill Lynch report that were in line with analyst recommendations
and corporate guidance.
Long-Term Debt
I grew long-term debt by 1.73% for 2010, 1.43% for 2011 and 1.26% for 2012 based on analyst consensus from
MCD’s debt schedule and corporate guidance.
Dividends:
I used dividend estimates from multiple analysts; $2.25 for 2010, $2.45 for 2011, and $2.67 for 2012. MCD has
paid dividends on its common stock for 34 consecutive years and has increased the dividend amount each year.
The increases reflect MCD’s confidence in the ongoing strength and reliability of its cash flow. I fully expect
these dividends to continue to increase over the next three years.
CapEx
I used what MCD previously spent on CapEx in 2009, and grew this based on previous CapEx growth rates.
VALUATION ASSUMPTIONS
Risk Free Rate
I used the EIF risk free rate of 4.5%.
Market Risk Premium
I used the EIF market risk premium of 5.7%.
Beta
I have used a beta of 0.63. This is slightly under the average beta I found of 0.65, with a low of 0.55 and a high
of 0.65. The regression analysis provided a beta of 0.86.
P/E multiples
I calculated and used the averages of analyst estimates for P/E multiples of 15.50x, 14.50x, and 15.00x in 2010,
2011, and 2012, respectively. Looking at the historical P/E, the five-year high P/E was 17.6 in 2007.
EPS
My EPS projections are $4.38, $4.72 and $5.14 for 2010, 2011, and 2012 respectively. I used Bank of America
Merrill Lynch’s projected shares outstanding for 2010, 2011, and 2012.
RECENT NEWS
McDonald’s Set For New High on Smoothies, Earnings?
Published: Friday, 16 Jul 2010 | 2:19 PM ET
Text Size
By: John Melloy
Executive Producer, Fast Money
McDonald’s shares are poised to break out to an all-time high next week as its earnings report shows the
world’s largest restaurant company is bucking an economic slowdown in Europe and the U.S. with menu
innovations, interior renovations and consumers’ hunger for savings.
The stock touched an all-time high Thursday before retreating, its fourth failure in three months to stay above
the $70 level. If analysts and investors are correct, its report next Friday should do the trick.
“We are encouraged that Europe continues to produce strong results despite the recent financial crisis,” wrote
Baird analyst David Tarantino in a report to clients at the end of June. “While the company did not provide a
specific update, management’s upbeat tone seemed to suggest that sales have not slowed meaningfully from
the strong results seen in May.” Tarantino rates the shares ‘outperform’.
McDonald’s rose this week as the Dow Jones Industrial Average was dragged down by disappointing results
from Bank of America. The stock has outperformed the Dow over the last 12 months, five years and decade as
the company consistently navigates its way through strong and weak global economies.
The restaurant chain “is uniquely positioned to leverage its pipeline and marketing scale through a recovery,”
wrote Credit Suisse’s Keith Siegner, in a note at the start of June. “At the same time, its unparalleled value
mind-share hedges the risk of a hiccup in recovery momentum.”
Its latest new product innovation, following such successes as the ‘McGriddle’, ‘Snack Wraps’ and premium
coffee, is the smoothie. McDonald’s began selling the cold, fruity drinks this week. Demand has been so great
that it had to suspend a free sampling event for next week.
“Smoothies are the most recent anticipated catalyst and European fears were misplaced,” said Pete Najarian,
co-founder of OptionsMonster.com and TradeMonster.com. The shares offer “great value, great growth and a
dividend yield when talk of returns is so pressing.”
The 2-year Treasury yield hit a record low this week as investors continued to flood into the safety of
government bonds on fears the global economy is facing another slowdown. Worries about a weak domestic
economy have seemed to trump concerns about Europe.
In the first quarter, U.S. sales were the weak link, growing just 1.5 percent. European sales jumped 5.2
percent. The stock sports a dividend yield of 3.1 percent and a below-industry-average price-earnings ratio of
16.5
Besides Smoothies and earnings anticipation, a reason for the most recent run in the stock could be the falling
dollar which makes McDonald’s products more affordable overseas, where it gets the majority of its sales. If the
Euro was to go back into a tailspin in the second half of the year, that could once again deny McDonald’s of that
$70 perch.
Sources:
Forbes.com
Yahoo Finance
IBIS World
Value Line
Morning Star
Dividend Monk
MSN Money
Thomson ONE
The Markets
MCD Annual Report 2009