-McDonald’s is one of the most well-known companies in the world, though it’s sometimes disliked or ridiculed.
-Five-year Earnings Growth Rate: 15%
-Five-year Dividend Growth Rate: 30% (latest increase was 10%)
-Over $14 billion in share repurchases over the past four years.
-My conclusion is that MCD is a solid buy under $70.
McDonald’s has been in business since 1940, and 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.
According to the 2008 annual report, 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 its products in 118 countries and operates over 31,000 restaurants. Approximately 80% are franchisee operated and the rest are operated by the corporation.
Revenue, Earnings, Cash Flow, and Margins
McDonald’s has been growing at a market-beating rate for years. Lately revenue has been a bit stagnant, but I think it’s likely they’ll continue strong as the economy improves.
Annual revenue growth has averaged about 5% per year for the past five years.
Earnings growth for the past five years has averaged nearly 15% annually which is excellent. Earnings-Per-Share are expected to grow by 11% in 2010 and 9% in 2011.
Cash Flow Growth
Cash flow has grown by a moderate 8% annually averaged over the past 5 years.
Net Profit Margin
MCD has an impressive net profit margin of 20%. This is up from their 5-year average of 15.7%. In comparison, Yum! Brands, the owners of Taco Bell, KFC, Pizza Hut, and others, has a net profit margin of only 11%, and Burger King has a net profit margin of only 8%. It’s not even close here.
McDonald’s switched from paying an annual dividend to a quarterly dividend in 2008. The current dividend yield is approximately 3.25%.
The dividend growth rate for this stock has been a whopping 30% over the past five years. This is a phenomenal growth rate. Imagine getting a 30% raise every year. Don’t expect that rate in the future, though. The latest raise was by 10% which is a more reasonable rate going forward. The relatively high yield combined with the good growth prospects should yield above average returns for the next several years.
In addition to the dividends, McDonald’s has repurchased $13.4 billion of its own stock over the past 4 years (compared to a market cap of $72 billion). Even after accounting for their small annual issuance of stock, this is still way more than they’ve paid in dividends over those same four years (dividend payouts were approximately $7 billion). From this it can be shown that almost all income from McDonald’s goes back to shareholders.
McDonald’s has a moderate balance sheet with a current ratio of 1.1 and a LT debt/equity ratio of 0.75. I’d like to see a little bit less leverage in my investments, but this is acceptable. They need to maintain market share in emerging markets and the time to expand is now so they utilize leverage. Burger King has a similar balance sheet, and Yum! Brands is highly leveraged with a LT debt/equity ratio of 3.13. As MCD’s main competitor seems to be Yum! Brands, this gives MCD far more freedom with expansion in the future.
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, a lot of people tend to think of it as an American thing. McDonald’s, however, takes in more revenue from Europe than from North America. The company takes in over $8 billion in revenue from North America, nearly $10 billion from Europe, and over $4 billion from APMEA (Asia-Pacific, Middle East, and Africa, as they call it). Sales growth in North America has been unimpressive (though positive), but sales growth in Europe and especially APMEA have been very impressive.
McDonald’s has been more about real estate than restaurants ever since Ray Kroc ran the company long ago. McDonalds 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 higher profit margins (McDonalds collects rent and royalties), but the corporate owned entities allow McDonalds to develop new products and new looks and keeps management fresh and knowledgeable.
The company has, basically since being founded, focused on quantity over quality. They sell inexpensive, supposedly tasty food to several million people per day. In the past few years, however, McDonald’s has acknowledged this shortcoming and has been focusing on quality over quantity. They’ve been remodeling their stores worldwide to include softer colors and more wood to replace the lame red and yellow plastic look. Some of their highest quality stores actually look like respectable places to eat and relax in. They’ve long-since launched their McCafe brand which is coffee shop and it’s grown at an excellent rate. The point is, McDonald’s management is on the ball, and I trust that they will build shareholder value.
When it comes to focusing on the shareholders, few do it better than McDonalds. As previously stated, 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 corporation has a policy in that all leaders have to own a significant amount of McDonald’s stock and hold onto it during their tenure. The CEO must own at least 6x his annual base salary worth of McDonalds stock. The President and the Board of Directors must all own at least 5x annual salary. District presidents, executive vice presidents, and senior vice presidents must own between 2 and 4x annual base salary. This keeps leaders in line with shareholders because they are significant long-term shareholders themselves.
MCD has moderate risk in my opinion. First of all, this company sells food worldwide, and food is relatively safe. They’ve got commodity cost risks, but people have to eat, and they feed a population equal to Italy every day. They’ve also got the best profit margins in the industry, so their profit is unlikely to be drained any time soon. They do face brand risks as people look for healthier options. The term “McDonaldization”, coined by author George Ritzer, refers to the process of a country taking on the characteristics of a fast food restaurant (specifically efficiency, calculablity, predictability, and control). Morgan Spurlock in his movie “Super Size Me” intelligently ridiculed McDonalds for its negative health trends. McDonalds, however, is aware of the trend and has been changing their restaurants for the better and have been offering healthier food options, so I see a cautiously bright future. McDonalds ensures that restaurants offer the type of food and environment that people in that region want. Districts have flexibility in what they want to offer. This flexibility allows a beef empire to spread even into India. I can speak from personal experience that their brand is not particularly of value to me and I have no desire to eat at their restaurants. McDonald’s has to stay sharp on brand management and health to succeed in the long-term.
Conclusion and Valuation
McDonalds currently has a PE of less than 17. This is lower than Yum! Brands but higher than Burger King. They’ve got massive international exposure, a safe business, only moderate leverage, extremely shareholder friendly management, and a good dividend yield. I think this would make a solid investment if purchased under $70 per share. By investing in MCD you get international exposure, a solid dividend, good earnings growth, and even better per-share earnings growth due to large share repurchases by the company. McDonalds is currently on my watch list- I’m debating buying shares of a restaurant that I don’t want to eat at even if I think it’s a good investment.
Full Disclosure: I own shares of none of the companies mentioned, but as mentioned, MCD is on my watch list for possible purchase.
You can see my full list of individual holdings here.
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