Distinct Competitive Advantage (Moat)?
Bigger is better (economies of scale). McDonald's is the world's largest fast-food chain with 35,000 restaurangs that are located in 118 countries, with an extensive distribution network to serve them all. Just like Walmart, McDonalds has a great bargaining power over it's suppliers, since many of them are dependent on McDonalds which in turn means that the company can buy in large quantities at reasonable prices. McDonalds is also one of the market leaders in most of its markets, even though the competitors have been catching up lately. China is the a market where McDonalds has struggled the most to make a significant footprint.
Location, location, location! Since McDonalds was first to market in many countries, the company has been able to secure great locations for it's restaurants. Management puts a great deal of effort into finding the very best locations. McDonalds often times own both the land and property, and if that's not the case they secure long-term leases.
McDonalds is still a strong brand in most countries and has a huge advertising budget that few companies can match.
McDonalds also has a proven franchise model (about 80% of restaurants are franchised restaurants), where the franchisee is responsible for the mayor part of the risk. Franchise restaurants account for big part of McDonalds revenue, which comes from rental fees, franchise fees and percentage of all restaurant sales.
A Company with Financial Strength?
McDonald's balance sheet is strong compared to it's peers, although there is some leverage there. The equity ratio (shareholders' equity) is about 43%. The interest coverage ratio is about 15 which means that they can cover their interest costs nearly 15 times. Free cash flow has been stable during the period and has covered the dividend by a margin.
The big real estate portfolio of restaurants also add strenght to the balance sheet in my opinion. McDonalds passes this criterion.
Risks and Uncertainties That May Affect Future Earnings?
I want to assure myself that political, regulatory, business and other specific risks that may affect a company's future earnings are as few as possible and preferably manageable.
Health trends have and will continue to put pressure on the fast food industry, McDonalds has however adapted by renewing their menus and offered healthier options in the past.
Tough competition primarily in the US, but also abroad, continues to put a damper on McDonald's profitability. Sales have dropt since last year due to lower guest traffic and comperable sales in existing restaurants in the U.S.
The political risk will always be there since brand is tightly asssociated with the U.S. and the american way. Recent shut downs of restaurants in because of alleged sanitary violations Russia attests to this fact.
Regulatory risk is another threat that McDonalds faces. There is a widespread dissatisfaction among restaurant employees in the United States over the low minimum wages, which is ceating bad press for the chain.
The supplier scandal involving expired meat in China has also had an substantial negative impact on profits this year thus far.
Even though McDonalds has hit a rough patch right now I think the company's strong position in the market place, strong cash flow and the it's abilty to over time adapt give it the tools to cope in this enviroment in times ahead. McDonalds passes this criterion.
Summary and Valuation
McDonalds meets all of my investment criteria. In my eyes, McDonalds is a solid company with competitive advantages as evidenced by the margins. Steadily increasing EPS and dividends have made McDonald's into an attractive stock to own historically. The big question is what the future looks like.
EPS and dividend growth have slowed down considerably lately. EPS for the last four quarters is down 9% compared to last years full year results. A big part of the recent decline in profitability has do to with the stiff competition and bad press that McDonalds has experienced in the U.S as well as a slow down in Europe. Other factors affecting earnings are the recent meat scandal in China and to a lesser extent the closing down of restaurants in Russia.
McDonalds hopes to increase sales in the U.S. segment by creating a more focused menu, since analysts have pointed out the chain's extensive menu as one of the reasons that sales have dropped lately.
To strengthen the results in APMEA (mainly China) McDonalds will focus on rebuilding confidence in the brand and updating the menu options so that it's more adapted to local preferences. The company will also open more restaurants in the region.
McDonalds will have spent a total of 5 billion on dividends and share repurchases at the end of the year. The share repurchases will contribute to VPA growth by between 2.5 - 3%.
Location, location, location! Since McDonalds was first to market in many countries, the company has been able to secure great locations for it's restaurants. Management puts a great deal of effort into finding the very best locations. McDonalds often times own both the land and property, and if that's not the case they secure long-term leases.
McDonalds is still a strong brand in most countries and has a huge advertising budget that few companies can match.
McDonalds also has a proven franchise model (about 80% of restaurants are franchised restaurants), where the franchisee is responsible for the mayor part of the risk. Franchise restaurants account for big part of McDonalds revenue, which comes from rental fees, franchise fees and percentage of all restaurant sales.
All these reasons above makes McDonalds stand out from it's competitors with strong cash flow and high margins. Morningstar believes that McDonalds has a wide moat and I can only agree with them. McDonalds gets a pass on this criterion.
Strong Owners?
I'd like to se a business that I own to have strong owner behind it with financial muscle. I usually prefer a company that is family owned, since you tend to take better care of things close to home.
A Truly Global business?
The US accounts for 32%, Europe 39% and APMEA (Asia / Pacific, Middle East, Africa) for 23% of the revenues.
Of revenue from Europe the UK, Germany and France account for about 51%. Of the proceeds from APMEA China, Australia and Japan stands out with 56% of the revenues. McDonalds is multinational company in the true sense of the word. McDonalds passes this criterion.
The US accounts for 32%, Europe 39% and APMEA (Asia / Pacific, Middle East, Africa) for 23% of the revenues.
Strong Owners?
I'd like to se a business that I own to have strong owner behind it with financial muscle. I usually prefer a company that is family owned, since you tend to take better care of things close to home.
The bigest shareholders are: Vanguard Group, State Street Corporation and BlackRock Institutional Trust Company. McDonalds passes this criterion.
The profit margin has grown from about 9.1% in 2003 to almost 20% in 2013!
A Dividend that has on Average Risen over the Period of 10 Years?
McDonalds has increased its dividend every year since 1976. This is how the dividend has developed over the past 10 years.
The average dividend growth per year has been about 22%. I can't see McDonalds dividend streak coming to an end anytime soon, although the dividend growth has slowed down considerably in recent years. The payout ratio has risen during the period and in 2013 the payout ratio stod at 56,2% and is about 66% right now. McDonalds passes this criterion.
A Business That is Easy to Understand?
McDonalds business is easy to understand and get a grip on. The company aquires restaurants at strategic locations and sells a tested and established concept with a strong brand to franchisees. The concept is further developed (menus, décor, etc.) and franchisees are trained. The McDonalds brand is managed by means of a huge advertising budget and the company receives most of it's revenue from the franchisees.
McDonalds passes this criterion.
McDonalds business is easy to understand and get a grip on. The company aquires restaurants at strategic locations and sells a tested and established concept with a strong brand to franchisees. The concept is further developed (menus, décor, etc.) and franchisees are trained. The McDonalds brand is managed by means of a huge advertising budget and the company receives most of it's revenue from the franchisees.
McDonalds passes this criterion.
Rising Earnings Per Share (EPS), That Have Grown on Average at Least in Line with the Dividend for 10 Years?
McDonalds passes this criterion since the average increase per year was about 15% over the period.
Sales growth has also contributed to the growth of VPA and averaging approximately 6% per year over the same period.
McDonalds also has an extensive repurchase program of shares where they spend an average of 3-4 billion dollars each year. The number of shares has fallen by more than 20% during the period 2004-2013 as a result of share repurchases.
The chart below shows how the company's earnings per share (EPS) and profit margins have developed during the period 2004-2013.
McDonalds passes this criterion since the average increase per year was about 15% over the period.
McDonalds also has an extensive repurchase program of shares where they spend an average of 3-4 billion dollars each year. The number of shares has fallen by more than 20% during the period 2004-2013 as a result of share repurchases.
The chart below shows how the company's earnings per share (EPS) and profit margins have developed during the period 2004-2013.
McDonalds does get a pass on this criterion.
A Dividend that has on Average Risen over the Period of 10 Years?
McDonalds has increased its dividend every year since 1976. This is how the dividend has developed over the past 10 years.
A Company with Financial Strength?
McDonald's balance sheet is strong compared to it's peers, although there is some leverage there. The equity ratio (shareholders' equity) is about 43%. The interest coverage ratio is about 15 which means that they can cover their interest costs nearly 15 times. Free cash flow has been stable during the period and has covered the dividend by a margin.
The big real estate portfolio of restaurants also add strenght to the balance sheet in my opinion. McDonalds passes this criterion.
I want to assure myself that political, regulatory, business and other specific risks that may affect a company's future earnings are as few as possible and preferably manageable.
Health trends have and will continue to put pressure on the fast food industry, McDonalds has however adapted by renewing their menus and offered healthier options in the past.
Tough competition primarily in the US, but also abroad, continues to put a damper on McDonald's profitability. Sales have dropt since last year due to lower guest traffic and comperable sales in existing restaurants in the U.S.
The political risk will always be there since brand is tightly asssociated with the U.S. and the american way. Recent shut downs of restaurants in because of alleged sanitary violations Russia attests to this fact.
Regulatory risk is another threat that McDonalds faces. There is a widespread dissatisfaction among restaurant employees in the United States over the low minimum wages, which is ceating bad press for the chain.
The supplier scandal involving expired meat in China has also had an substantial negative impact on profits this year thus far.
Even though McDonalds has hit a rough patch right now I think the company's strong position in the market place, strong cash flow and the it's abilty to over time adapt give it the tools to cope in this enviroment in times ahead. McDonalds passes this criterion.
McDonalds meets all of my investment criteria. In my eyes, McDonalds is a solid company with competitive advantages as evidenced by the margins. Steadily increasing EPS and dividends have made McDonald's into an attractive stock to own historically. The big question is what the future looks like.
EPS and dividend growth have slowed down considerably lately. EPS for the last four quarters is down 9% compared to last years full year results. A big part of the recent decline in profitability has do to with the stiff competition and bad press that McDonalds has experienced in the U.S as well as a slow down in Europe. Other factors affecting earnings are the recent meat scandal in China and to a lesser extent the closing down of restaurants in Russia.
McDonalds hopes to increase sales in the U.S. segment by creating a more focused menu, since analysts have pointed out the chain's extensive menu as one of the reasons that sales have dropped lately.
To strengthen the results in APMEA (mainly China) McDonalds will focus on rebuilding confidence in the brand and updating the menu options so that it's more adapted to local preferences. The company will also open more restaurants in the region.
McDonalds will have spent a total of 5 billion on dividends and share repurchases at the end of the year. The share repurchases will contribute to VPA growth by between 2.5 - 3%.
The bigest key to speeding up the VPA-growth is to increase the comparable sales and guest the count in existing restaurants within the established markets. The company has conceded that it hasn't done enough in this area and has for this reason developed three specific strategies to increase their relevance for the customer:
- Modernization and improvement of McDonald experience (trademark, restaurants, menus and customer service).
- Shorteing and simplifying the ordering and payment process with new technology such as mobile, web, and payment solutions. McDonalds has for this reason joined Apple Pay.
- Use existing resources more effectively to realize the points above.
McDonalds is, despite the recent problems, one of the most stable and share friendly company you can own in my opinion. What Am I then willing to pay for such a high quality company that I believe Mcdonalds to be?
Valuation
My Price Cap is equivalent to 83,5 dollars. The Price Cap constitutes the price I'm willing to pay at the most for a given stock. The Price Cap is the average value obtained when Fair Price 1 (based on dividend growth and dividend yield) and Fair Price 2 (based on sustainable EPS and Sustainable P/E ratio) are compared. My Price Cap for McDonalds is based on the following assumptions:
Valuation
My Price Cap is equivalent to 83,5 dollars. The Price Cap constitutes the price I'm willing to pay at the most for a given stock. The Price Cap is the average value obtained when Fair Price 1 (based on dividend growth and dividend yield) and Fair Price 2 (based on sustainable EPS and Sustainable P/E ratio) are compared. My Price Cap for McDonalds is based on the following assumptions:
- I estimate that McDonalds will have an average dividend growth rate going equivalent to about 8% going forward.
- I estimate sustainable EPS to be roughly 5,5 dollars and sustainable P/E-Ratio, based on the company's qualities to be 18.
This concludes my stock analysis on McDonald's. My plan is to publish several equity research in the coming weeks.
Have a nice day!
What do you think about the news of a large activist buying into McDonald's?
ReplyDeleteThat's news to me, I will have to look it up. The short answer is that it depends on the activists and his or hers agenda. If this third party can bring new and creative ideas to the table and aims to create long-term value, it's good news ;)
DeleteJana Partners has taken a stake in MCD by accumulating 1.042 million shares, inclusive of calls.
ReplyDeleteAccording to the investment manager’s website, “Jana typically applies a fundamental value discipline to identify undervalued companies that have one or more specific catalysts to unlock value. Jana can be the instrument for value creation by becoming an actively engaged shareholder.”
Maybe she has seen what I have in McDonalds. Sounds like she could be good for the Company!
DeleteAny thoughts on today's numbers? It has been a while since we saw growth...
ReplyDeleteGold prices rose on Friday after hitting a more than six-month low in the previous session as the dollar retreated from recent highs amid a rising euro, but the yellow metal looked set to post its sharpest monthly fall in 19 months.
ReplyDeleteCapitalstars