Stock Analysis
McDonalds Corporation (MCD)
FINA 4200, Fall 2009 Semester
Group Number 4
Julian Johnson
Josh Dunmire
Ming Kai Low
Payton Rippa
Nicole Mucheru
Pamela Whipple
Theme:
When looking at different companies to invest in, it can be very exciting to look at new
markets and emerging industries as a way to get ahead in the game. However, it is
also worth looking at companies that have been around for a long time as well as
companies that are familiar. While the first thing one might think of when hearing
McDonalds may not be investing, it is worth noting that McDonalds is a large and
multinational company spanning 120 countries. It has been around for over sixty years
and it is safe to say that it will be around for quite a while.
Business Analysis: Profile
McDonalds is first and foremost a fast food hamburger restaurant. They have stayed
true to that from the very beginning. In recent years they have expanded beyond the
simple hamburger and french fries that make them so famous. In keeping with health
conscious individuals, they began to market yogurts and light salads as well as adding
Dasani water to their menu. They are also willing to branch out to unexplored markets
with the introduction or their McCafe iced coffees which are clearly aimed at competing
with Starbucks Coffees. McDonalds was, at one point, the largest global restaurant
chain in the world. Because they operate internationally, the company also has several
foods and meals that are specific to the region. This shows the company’s ability to be
flexible and proves that they do not use a “one size fits all” approach to their business.
McDonalds Corporation has owned some other very well known restaurants including
Chipotle and Boston Market. They sold the stake in these companies and began to
concentrate heavier on broadening the appeal of McDonalds to the health conscious
young adult.
Macroeconomic Analysis:
The fast food industry is very competitive in the United States. Among McDonalds
Competitors are Subway Restaurants, Yum! Brands Inc. (Taco Bell, KFC, etc) and
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Burger King just to name a few. All of these companies actively compete with
McDonalds and it is apparent in their marketing and advertising.
The Fast food industry as a whole is thriving in the US and abroad. As people become
busier, they turn to a quick meal when they do not have time to make it themselves.
This has changed from the 1940s when McDonalds first opened, and dinner was
usually enjoyed at the home and cooked there as well. Many of these companies have
several restaurants located within close proximity to one another, sometimes as close
as a couple of miles apart. Stephen Von Worley did a study that showed that no matter
where in the US you were, you would never be more than 107 miles from a McDonalds
restaurant. This is truly an amazing fact and it should be noted that they are usually
much closer than that. One problem that can arise as a result of so many restaurants in
close proximity is “cannibalization”, wherein two stores are so close that one gets all of
the business and the other merely takes up space. McDonalds does not suffer from this
problem like some firms in the industry have, given the economic downturn.
Another element common among fast food restaurants is their price range. Generally
they are reasonably priced, if not very inexpensive. Many such places have “Dollar” or
“Value” menus which attempt to make the most of the consumer’s dollar. McDonalds is
by far the leader in this category keeping consumers readily aware of the products their
dollar menu offers.
Analysis of the Company:
McDonalds offers breakfast, lunch and dinner meals and is open for business early in
the morning, to late at night in most areas. Like many other restaurants in their industry,
they boast a drive-through that is open even later than lobby hours, which appeals
largely to college-aged consumers. As noted earlier, they also provide several health
conscious items due to the rising health trend in the US. In previous years McDonalds
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had received a great deal of criticism for their food and the way it was prepared. They
took several corrective steps to ensure that they made their products in the healthiest
way possible, for example cooking their french fries in vegetable oil. In addition to
offering yogurt and salad, they also offer a line of low fat snack wraps, which are easy to
eat on-the-go. All of this to say that it does not matter if you are looking for a quick
burger or a healthy snack, McDonalds has put a lot of time into expanding their market
to meet the needs of the many different lifestyles of their customers.
Financial Analysis:
Financial analysis is an aspect of the overall business finance function that involves
examining historical data to gain information about the current and future financial
health of a company. Here, we are going to focus on analyzing McDonald’s profitability
and compare key ratios with the industry ratios.
Valuation Ratios:
P/E Ratio (TTM)
Price to Cash Flow
(TTM)
ROE
Beta
MCD
15.75
11.70
BKC
12.53
8.07
Industry
17.45
10.12
S&P 500
19.40
6.80
30.1
0.56
21.97
0.39
43.3
-
15.2
-
P/E Ratio:
The P/E ratio is a valuation of a company’s current share price compared to its pershare earnings. The higher the P/E ratio interprets an increase in the earnings growth
rate in the future. MCD’s P/E ratio is higher than its competitor BKC but it is slightly
lower than the industry and the S&P 500’s P/E ratio. This also reflects that MCD has a
slow but steady growth rate. According to table 1.1a, the P/E ratio of MCD has been
rising from year 2005 to 2007 and crashed at year 2008 when the stock market
crashed. However, estimates from table 1.1b and graph 1.1a shows that there is a
growth in earnings during the 4th quarter of 2009 until year 2010.
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Table 1.1a taken from www.morningstar.com
Graph 1.1a taken from
moneycentral.msn.com
Table 1.1b taken from
moneycentral.msn.com
Price to Cash Flow:
The price to cash flow ratio is used to compare a company’s market value to its cash
flow. MCD’s price to cash flow is higher than the industry’s ratio. A higher ratio means
that the cash flow is low relative to the stock’s price.
Return on Equity:
The return on equity ratio is used to measure a firm’s efficiency at managing its total
investments in assets and in generating a return to stockholders. MCD’s ROE is higher
than its competitors and the average of S&P 500. This shows that the stockholders
would get more than other stocks in the related industry.
Beta:
Beta is the measure of volatility in comparison to the market as a whole. The lower beta
means that the security will be less volatile than the market. However, it is normal for
most companies to have a beta less than 1. MCD is more volatile than BKC.
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Summary of Valuation Ratios Analysis
The P/E ratio shows that the stock has a potential of making money at a slow pace as it
is already the leader among other competitors in the fast food industry. The P/CF ratio
for MCD is overvalued and shows that the cash flow is low. MCD’s ROE is high and
shows that it has a capability of generating more revenue with its assets. The beta
analysis shows that MCD is more volatile compared to BKC. Stocks with a Beta greater
than 1 will fall more aggressively if the equities market continues to depreciate. This
makes for a less risky buy of the stock. These ratios are favorable when considered
together. They are higher compared to the competitor’s even though they are still lower
than the combined industry and S&P 500. The stock is worth buying for the long run
with slow and constant earnings.
Projection of sales:
2006
2007
2008
Revenue
21,586.40
22,786.60
23,522.40
Gross Profit
6,984.30
7,905.20
8,639.20
The above data shows revenue and gross profit (in thousands) for MCD from year 2006
to 2008. The table shows that MCD has gradually increased in revenue and gross profit
over the years. With prime locations located all around the world and cheap value food
meals offered to customers during this recessionary period, MCD is projected to gain
more in coming years.
Gross Margin:
5
Gross Profit
Margin
MCD
38.1%
BKC
35.22%
Industry
32.3%
S&P 500
37.3%
The above data shows MCD revenue (in thousands) in comparison to the gross profit
margin. The Gross Profit Margin is used to measure how each company’s dollar
revenue meets expenses and profits after paying for goods or services that were sold.
MCD’s GPM has a favorable growth rate over the past three year despite recessionary
activities that had happened recently. When compared to the competitor BKC, the
industry and S&P500, MCD’s gross profit margin stands out. This also shows that MCD
is more efficient and can make a reasonable profit on sales compared to other
competitors.
Operating Margin:
30.00%
25.00%
20.00%
15.00%
Column2
10.00%
5.00%
0.00%
21,586.40
2006
22,786.60
2007
23,522.40
2008
The above data shows MCD revenue (in thousands) in comparison to the operating
margin. Operating Margin is a measurement of a company’s efficiency in operating.
Over the past 3 years, the operating margin dropped from 21.2% to 17.5% at year 2007
but rose to 28.4% at year 2008. However, the revenue has been rising gradually to
reach $23,522.40, despite recessionary activities that had been happening. Economists
are currently incapable of predicting when our economy will recover to a healthy growth
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rate. However, it is our prediction that MCD earnings will grow higher during the next
year.
Profit Margin:
Net Profit Margin
MCD
18.34%
BKC
7.89%
Industry
(0.05%)
S&D 500
5.53%
The above data shows MCD revenue (in thousands) in comparison to the net profit
margin. Net profit margin is used to measure how much out of every dollar of sales a
company actually keeps in earnings. Although the revenues are rising across the three
years, the net profit margin dropped at 2007, but it rose higher to 18.3% which is higher
than 16.4% in 2006. This shows that with a higher profit margin, MCD is a more
profitable company that has better control over its costs compared to its competitors .
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Forecasted Results on EPS:
Table 1.2a taken from hoovers.com
Earnings per share (EPS) are the earnings returned on the initial investment amount.
The EPS is going to be slightly lower in the next quarter. It is predicted that the EPS will
drop to 0.95 in the next quarter, but the overall EPS will rise from $3.91 to $4.31. The
EPS growth rate for MCD is positive.
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Taken from http://www.valuecruncher.com/valuations/87646/edit
Above is an estimation of revenue projected in the next five years. The revenue is
expected to grow gradually at a slow pace. McDonalds revenues will grow to $25 billion
in 2010, representing an annualized growth rate of 3.14% over the next three years.
This growth will be driven by a combination of organic growth of existing stores and the
ongoing opening of new stores.
Taken from http://www.valuecruncher.com/valuations/87646/edit
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The earnings before tax, depreciation and amortization (EBITDA) margin are a margin
that measures cash earnings without accrual accounting. EBITDA margins are
projected to grow from 31.5% in 2008 to 33.5% in 2010 reflecting MCD’s strategy of
focusing on franchised and affiliate stores.
Stock Valuation:
We began in our process of valuing McDonalds stock by comparing the P/E ratios of
McDonalds versus the industry average and two of McDonalds largest competitors:
Burger King (BKC), and YUM! (YUM).
P/E Ratios
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10
0
MCD
BKC
YUM
Industry
Data found at www.reuters.com
McDonalds P/E ratio is 15.29, compared to Burger King’s 12.19, and YUM!’s 15.45.
The industry average is 14.08. Burger King, McDonalds closest competitor is well
below the industry average, while McDonalds is above the industry average. McDonald
is lagging slightly behind YUM! in this analysis.
In addition, we used the Dividend Discount model to arrive at the fair value of a share of
McDonalds stock. Our calculations were as follows:
Vo= Dt + Po / 1 + k
Where Vo = Value of Stock
Dt = Dividend payment at “t” time
k = Required return by CAPM
We first calculated CAPM using the formula rf + β(rm – rf), where rf = risk free rate, rm =
market rate, and β = beta. We found the beta of .65 from Reuters.com, and the risk free
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rate from the currently listed 3-month treasury bill rate. The market rate was calculated
using the following Excel format:
Year
2004
2005
2006
2007
2008
Stock Return
31.3
7.3
34.4
36.3
8.3
Probability
0.20000000
0.20000000
0.20000000
0.20000000
0.20000000
TOTAL
Stock Return
Probability
6.26
1.46
6.88
7.26
1.66
23.52
Therefore, our equation is: k=.10 + .65(23.52 - .10) = 15.32.
REQUIRED RATE OF RETURN
CALCULATION
risk free rate (Rf)
expected market return (Rm)
beta
0.10%
23.52%
0.65
required return (k)
15.32%
The dividend amount for 2008 was $2.05, according to Morningstar.com, so the Fair
Value was calculated as: $2.05 + $59.02 / (1 + .1532) = $53.23. This compares to the
ending market price per share of $59.02 at day end on October 27, 2009. It is obvious
that McDonalds shares are trading at a premium of fair value. Interestingly,
Morningstar.com analysts valued McDonald’s shares at $63.00 per share due to sales
growth and profitability in the 3rd quarter of 2009 in a very competitive market and their
belief that the chain will capture additional market share as a result of increased
adoption of the Angus Third Pounder hamburger and McCafe specialty coffee offerings.
Next, we reviewed the Price-to-book ratio for McDonalds. This ratio measures the ratio
of price per share dividend to book value per share. From Morningstar.com, we found
the McDonalds Price/Book ratio was 4.9 versus the industry average of 3.8. Many
analysts feel that this ratio is important in determining how strongly the market values
the firm.
We also looked at the Price-to-cash flow ratio for this company. This ratio is
instrumental in negating any errors or manipulations of results on the financial reports
by tracking actual cash flowing into and out of the company. McDonalds Price/Cash
Flow is 11.6 versus the industry average of 10.0.
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We calculated our anticipated dividend growth rate using the growth rate model, and the
results were as follows:
Stock:
MCD
Date
Dividends
Annual Dividend
2.05
Dividend growth rate
26%
11/27/2009
0.55
11/26/2008
0.50
1.50
1.63
1.50
9%
50%
11/13/2007
11/13/2006
1.00
1.00
49%
11/10/2005
0.67
0.67
Arithmetic Average
Geometric Average
Min
Max
Std Dev
33.42%
32.26%
9%
50%
20%
We decided to use the geometric average calculation because of its higher level of
accuracy. We then compared our calculated growth rate to that of the analysts at
Reuters.com. They have projected a growth rate of 32.36. The difference is obviously
negligible.
Bulls vs. Bears
Every stock has a bull and bear view. The bulls are the buyers, and the bears are the
sellers. A “bull market” is a financial market of a group of securities in which prices are
rising or are expected to rise. Bull markets are characterized by optimism, investor
confidence, and expectations that strong results will continue. With this type of market
and confidence, investors are more likely to buy in anticipation of making a capital gain.
The term “bull market” can also be applied to anything that is traded, such as bonds,
currencies, and commodities.
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A “bear market” on the other hand is a market condition in which the prices of securities
are falling, and widespread pessimism causes the negative sentiment to be selfsustaining. As investors anticipate losses in a bear market and selling continues,
pessimism continues to grow. In order for a bear market to be present, a downturn of
20% or more in multiple broad market indexes over at least a two-month period must
occur. This must not be confused with a correction, which is a short-term trend that has
duration of less than two months.
In the past, McDonald’s (MCD) has offered almost the same if not better food choices
as its competitors, Burger King, Wendy’s and Jack-N-the-Box just to name a few. All of
these fast food restaurants offered the same $1 burgers and other similar food but MCD
has been the only restaurant to be blamed for obesity problems in the United States.
MCD tried to change their reputation by offering healthier foods like salads, lean burgers
and grilled chicken meals. This helped them a little, but their prices were deemed too
expensive for their customer’s needs during an unpleasant economy. During the
summer of 2009, MCD released its new $3.99 Angus third pounder and a new line of
McCafe coffee drinks to boost sales. Their strategy worked for the most part, increasing
its sales for the month of August by 2.2% (investorguide.com). Its new coffees were
and still are a big hit because it’s just as good if not better than Starbucks coffee, but
mainly because it’s cheaper. Although MCD’s profits grew over 2%, completion from
Burger King’s $1 Whopper Junior and Wendy’s 99-cent Double Stack burger are still
making it difficult for MCD to become number one in their industry.
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Bull View
One reason to be “bullish” with this stock is the fact that MCD has been criticized about
serving unhealthy food, and since then has changed that, which has caused their sales
to increase. Their introduction of new and healthier food brought back old clientele and
has even attracted some new clientele. Its Angus burger is a little higher in price than
most burgers offered at other fast food chains, but MCD offers better quality meat,
something that is important to customers. Its McCafe drinks have attracted former
Starbucks customers who feel MCD is starting to direct their production on the
preferences of the customers. Although this introduction of healthier food didn’t
increase profits dramatically, it’s making progress slowly. MCD has also renovated its
menu and appearance to portray a new and improved MCD. No matter how bad the
economy gets, fast food restaurants can still thrive if they think properly and focus on
the needs of their customers. Presently, MCD is said to be bearish in the long-term
sense.
Bear View
MCD’s higher prices, compared to other fast food restaurants, may cause the company
to suffer. Although better quality food is a plus, many can’t afford the more expensive
items MCD has introduced. Also, their breakfast menu is suffering because of the
increasing unemployment rate, which results in fewer commuters. Less commuters
leads to decreasing sales and lost shares. The unemployment rate is also having an
effect on teenage summer jobs. Summer time is when MCD experiences most of its
sales and with the decline of business commuters and summer employees, MCD is
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trying everything to avoiding failing, mostly by being more aggressive in new product
development.
Moat
A moat represents an economic barrier that protects a company and its profits
from competing companies. Based on companies in the same industry, if company A
has a competitive advantage over company B and it looks as though that advantage will
not change in the future soon to come, Company A has a Moat. McDonalds has two
large moats that have stood the test of time: size advantage and cost advantage.
McDonald’s is the largest fast food chain in the world, operating in 100 countries
globally. Thus, it most definitely has a size advantage Moat. The size of McDonalds
allows it to create the same of a better product at a lower cost, not only because of bulk
purchases, but because of lower advertising costs based on scale.
More importantly, McDonalds has a moat based on cost advantage. Like listed before,
McDonalds can undercut its competitors with the same or better product, at a much
reduced price. This forces their competitors to have to attack their market share using a
different strategy than price.
Risk
McDonalds risk factor is almost nonexistent due to its size relative to the rest of the
industry. Since going public, McDonalds has shown stable growth. More recently, for
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example, over the last year, McDonalds (MCD) has varied from 50.44 to 64.46, showing
a 52-week change of 12.01% and an S&P 52-week change of 23.13%.
Beta:
0.56
52-Week Change3:
12.01%
S&P500 52-Week Change3:
23.13%
(06-Jan-09)3:
64.46
52-Week Low (05-Mar-09)3:
50.44
50-Day Moving Average3:
56.81
52-Week High
200-Day Moving Average3:
56.42
All statistics are courtesy of Yahoo Finance Taken on Sunday Oct 25 2009.
McDonalds is an incredibly stable stock. Even in our recent economic rollercoaster ride,
its 50-day moving average and its 200-day moving average are only separated by $.49.
Once again showing its ability to weather any kind of economic climate.
For an example of a slice of its competitors, over the past 52 weeks, Burger King
Holdings (BKC) has varied from 15.61 to 24.48, showing a 52-week change of 6.57%
and an S&P 52-week change of 16.32%. Over the past 52 weeks, Wendy’s/Arby’s
group (WEN) has varied from 2.63 to 5.80, showing a 52-week change of 52.82% and
an S&P 52-week change of 16.32%. Over the past 52 weeks, Jack in the box (JACK)
has varied from 11.82 to 30.35, showing a 52-week change 31.88% and an S&P 52week change of 16.32%. (The change % is listed below in a more accessible format)
52-week change
McDonalds(MCD)
12.02
Wendys/Arbys Groups(WEN)
52.82
Burger King Holdings(BKC)
Jack in the Box(JACK)
16
6.57
31.88
While the numbers show that Burger King is technically less “volatile”, McDonalds
experienced a 6.57% change, as opposed to a 12.02% change. You will see below that
Burger King Holdings has shown a loss over the past 52 weeks, while McDonalds has
shown a much larger gain.
Oct 24/2008
Oct 23/3009
BKC
18.33
17.90
MCD
53.06
59.43
The proof is in the pudding. The results show stable, consistent, growth. The key word
here is growth. While other companies such as Burger King are less volatile, they are
showing less growth, which actually makes them more risky. All of these factors put
together make McDonalds a sound investment from a risk standpoint.
Investment Strategies for McDonalds
McDonalds is the largest chain of hamburger fast food restaurants. They serve nearly
47 million customers daily and at one time were the largest global restaurant chain, but
have been passed by multi-brand owner YUM! Each McDonald’s restaurant is operated
by a franchisee, an affiliate, or the corporation itself. A lot of the corporations’ revenues
come from the rent, royalties and fees paid by all the franchisees, as well as sales in
company-operated restaurants. McDonald’s revenues have grown 27% over the three
years from the beginning of 2008 to $22.8 billion, and 9% growth in operating income to
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$3.9 billion. Although they have a lot of investors in their stock, this isn’t the only way
they do their investing. From being a landlord, to flipping burgers they try to revenue
wherever they can. McDonald’s is one of the most successful companies in the market
today and even through our recession is still building and coming along strong.
McDonalds primarily makes its money by people investing in their company. They get
people to invest by believing in their mission statement and by impressing their
investors with a prominent future. McDonald’s ending stock quote as of October 23,
2009 is at $59.43. It’s been going up steadily and doing really well even in our recent
recession. Because of its success, the company has a lot of people to thank for this
growing transition. The breakdown of major holders of this company is: 0% of shares
are held by all insiders and 5% owners. Percentage of shares held by institutional and
mutual fund owners is 73%. Percentage of float held by institutional and mutual fund
owners is also 73%. McDonalds also had 1193 institutions holding its shares.
Some of the major direct holders McDonalds has are Vice President and CEO of James
A. Skinner, who owns 189,693 stocks. Second on the list is John W. Rogers Jr. with
approximately 77,500 shares. Because of the success of this company as far including
the making of the McCafe, there are many top institutional holders as well. Capital
World Investors is at the top of the list with 62,385,700 shares and is valued at
$3,586,553,893. Second on the list is FMR LLC with approximately 48,760 shares and
is valued $2,803,221,138. Some of the top Mutual Fund Holders that the company has
are: Fidelity Contrafund Inc with over 21 million shares and valued at over 1.2 billion
dollars. All these companies don’t own this stock just to own. They’ve done their
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research on the company and their profits. McDonalds doesn’t wait around for products
to get boring, they make their sustainable advantage count.
Analyst’s opinion on MCD is that it is a very strong buy right now. Many predict it to get
even better than it is now. Over the past several months, many have recommended
investors to buy the stock and if you already have it, to hold it as long as you can. Of all
of the analysts that research this company, not one has recommended that investors
should sell the stock. Top-ranked analysts in the restaurants industry, calculating EPS
accuracy for MCD, have ranked that as a stock, MCD averages at least 4 starts out of 5.
Overall as a company it averages 4 out of 5.
Focusing on its core brand, McDonalds began divesting itself of other chains it had
acquired during the 1990s. Such companies are Chipotle Mexican Grill which it owned
until 2006 when it finally parted ways and sold its entire stake. Another restaurant that it
previously owned is Donators Pizza, which they also eventually sold in December 2003.
Previously in August 27, 2007, McDonalds also sold Boston Market to Sun Capital
Partners. One company brand that the company also operates is Piles Café.
McDonalds is a global company that conducts business over 120 countries. Although
they are a very successful food chain, they invest and own some of the most valuable
real estate property in the world, making them one of the top property investment
companies worldwide. It doesn’t just run fast food franchises, but is the landlord. They
own the land and building, and lease the property to its franchisee restaurants.
Research shows that of its total assets, land value accounts for over 25% of its value,
and it will continue to rise as more franchises become established. This statistic makes
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McDonalds a top-class property investment corporation and landlord for many franchise
owners around the world. Some places where their prime real estate property is located
include India, The Middle East, Asia, and Africa. Although the recession this year will
hurt its profit, its property investment holdings will help minimize the damage. With the
company having lower property value, comes lower rent for the franchise, which in the
end will make McDonalds brand the largest and strongest fast food franchise business
worldwide.
As you can see, McDonalds is going to be strong for a long time. They have a very
strong plan that they will continue to follow and will keep proving to investors that theirs
is a company that they should follow and invest in.
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