Mcdonalds’ economic performance can be evaluated by analyzing its beta value of 0.34, suggesting that Mcdonalds is a low-risk stock in comparison to the market. To assess the financial influence of economic conditions on Mcdonalds, it is essential to examine three economic indicators: the leading economic index (LEI), coincident economic index (CEI), and lagging economic index (LAG). These indices are intended to summarize and emphasize typical trends in economic data, providing a more comprehensive comprehension than assessing each component separately.
The Leading Economic Indicators (LEI) are indicators that provide early signals of economic changes and serve as a short-term predictor of the economy. In October, the LEI for the U.S. increased by 0.2 percent to reach 96.0, following a 0.5 percent increase in September and a 0.4 percent decline in August, indicating potential improvement in the future state of the economy.
On the other hand, the Coincident Economic Indicators (CEI) offer information on the current state of the economy. In October, the CEI for the U.S. grew by 0.1 percent to reach 104.8.
September saw a 2 percent increase, which contrasts with August’s decline of 0.4 percent, indicating some improvement in the current economy but not significantly. Lagging indicators like the LAG index typically change after the overall economy does and usually have a lag of one to two quarters.
In October, the LAG index reached 117.1 with a 0.3 percent rise following a 0.1 percent decline in September and a 0.4 percent increase in August. Considering that employment rate is considered as a lagging indicator, it is expected that the LAG index will grow during this sluggish economy.
LEI, CEI, and LAG analysis suggests moderate economic growth until 2013, but hurricane Sandy’s negative impact may not be accounted for. Now let’s focus on the fast food industry as a whole, specifically exploring Porter’s 5 forces and ROIC. McDonald’s has thrived globally with over 33,000 locations and plans for expansion. In contrast, Burger King has fewer than 13,000 international locations as compared to McDonald’s.
McDonalds is the leading force in the fast food industry, thanks to its extensive reach, which gives it a notable edge over rivals (2). Although unlikely, there is still a chance for a newcomer chain to contest McDonalds. The influence of suppliers is relatively insignificant (1.5) since McDonalds can acquire affordable ingredients from different sources. Moreover, the buying power of customers is low (1.5) due to McDonalds’ ability to offer budget-friendly choices that appeal to a wide range of consumers.
Despite McDonald’s attempts to provide salads and fruit as alternatives to their regular fast food offerings, the risk of substitutes remains significant (3.5). This is because more Americans are becoming conscious of obesity concerns and the significance of maintaining a well-balanced diet. However, the majority of customers who patronize fast food restaurants primarily seek affordable and fulfilling meals. Consequently, the concept of obtaining a salad from a fast food establishment does not attract many individuals. As a result, the entire fast food sector encounters intense competition (4), leading to comparable prices and choices within the industry.
Typically, people choose fast food restaurants for the sake of convenience rather than having a specific preference for a particular chain. McDonald’s has an advantage in this regard because it is widely available. In the next five years, we predict that there will be minimal changes in the industry’s five forces. As the industry moves forward, we expect limited alterations among new entrants, suppliers, and buyers. The fast food sector is likely to retain its established position with a low risk of new competitors (2.5).
Given McDonalds’ dominant market position, the chances of a new competitor emerging are slim. Nevertheless, there is potential for fresh suppliers and more cost-effective supply approaches, which would not significantly alter supplier power (1.5). Likewise, buyer power is projected to stay low (1.5) due to McDonalds’ already reasonable prices. Conversely, the threat of substitutes is anticipated to rise (4.5), propelled by the increasing demand for nutritious food options. As a result, promoting healthy choices through advertising will become more important and encourage sustained efforts towards healthier eating habits.
The rivalry in the industry will remain fierce as new companies emerge and compete to surpass their competitors in terms of healthiness (4.5). However, McDonald’s dominance will endure, further strengthening its overall advantages. To evaluate how effectively McDonald’s allocates its capital to profitable investments, one can analyze the Return on Invested Capital (ROIC) which achieved a rate of 21.49% in the previous fiscal year. Additionally, the ROIC can be used to assess McDonald’s performance compared to the industry with an average ROIC of 22%. It is also worth noting that McDonald’s had a Weighted Average Cost of Capital (WACC) of 6.51%, providing further insight into their financial position.
McDonald’s has a 59% spread compared to the industry average WACC of 7.49%. Although this doesn’t show a competitive advantage, the presence of Yum Brands skews the data with a spread of 24%. By removing this outlier, it becomes evident that McDonald’s does have a competitive advantage. The company also boasts the highest revenue among its immediate competitors, coupled with an efficient cost structure. These factors contribute to McDonald’s industry-leading profit margin.
The company’s competitive advantage in generating higher profits compared to its industry competitors is attributed to a larger investment of capital, which leads to a competitive Return on Invested Capital (ROIC) of 21.49%. The most effective way to evaluate the value generated for shareholders is by comparing the discrepancy between ROIC and Weighted Average Cost of Capital (WACC). McDonald’s, with its significant capital base and superior ROIC, possesses considerable potential for creating value both presently and in the foreseeable future.
After examining the historical cash flow for investors, it is evident that McDonald’s possesses a competitive edge in the industry. Over the past 5 years, the company has garnered $30.447B in gross cash flow as per its income statement. In terms of capital expenditures and reduction in working capital, McDonald’s reinvested $8.6B, accounting for 28% of its gross cash flow. This implies that excluding acquisitions, approximately 28% of the company’s cash earnings were allocated towards reinforcing its operations.
McDonald’s dedicated $579.6 million (2% of its gross cash flow) for acquisition premiums, amounting to reinvesting 30% of its gross cash flow into the business and designating the remaining 70% for payout. Despite this, the company experienced an increasing ROIC, indicating that these investments are expected to generate favorable outcomes in the future. The stock price chart during this time period reflects investor trust in McDonald’s ability to effectively manage its operations and cash flows.
Given that MCD operates in a mature and saturated market, it is logical for the company to prioritize returning cash to shareholders instead of pursuing growth. Non-operating cash flows remained relatively stable over five years with no significant changes. MCD incurred a non-operating loss of 3% of gross cash flow, equivalent to $845.5M. This resulted in 67% or $20.3B of gross cash flow available to investors. The financing aspect of MCD’s business reveals how the company funded its operations and utilized its free cash flow. Through a debt increase of $4.1B, MCD allocated 5% of after-tax interest expense or 13% of gross cash flow.
The company implemented a $2.5 billion share issuance and performed a $15 billion stock buyback simultaneously in order to enhance earnings per share and distribute cash to shareholders. They also allocated 36% of their free cash flow for common dividends. The stock price chart reflects investors’ approval of this strategy, as they continued purchasing the stock and supporting the company’s efforts to generate and distribute cash among shareholders. Analyzing MCD’s return on invested capital (ROIC) tree demonstrates a significant increase in their year-end ROIC over five years, progressing from 16.1% to 23.5%, which can be attributed to three distinct factors.
During the specified time period, several changes occurred in the company’s financial indicators. The Cash Tax Rate decreased by 9.6%, going from 34.6% to 31.3%. This decline contributed to an increase in ROIC (Return on Invested Capital). Additionally, there was a noteworthy rise in EOY Pretax ROIC, with a significant increase of 38.3% from 24.7% to 34.2%. To comprehend this growth, it is necessary to analyze the factors driving operating margin (profitability) and invested capital/sales (productivity). It is worth mentioning that MCD’s profitability consistently improved throughout the entire five-year period when evaluating the operating margin.
In 2007, the company’s operating margin was approximately 24.8%, but by 2011, it had risen to 31.6%, resulting in a profitability increase of around 27.5%. The invested capital to sales ratio showed that in 2007, the company borrowed about $1.002 for every dollar of revenue generated. However, in contrast, borrowing decreased to 92.4 cents for each dollar of revenue in 2011, indicating a decline of 7.8%. The main factors contributing to the increase in Return on Invested Capital (ROIC) of 45.3% include a significant improvement in operating margin by 27.5% and a decrease of the cash tax rate by 9.6%.
During the analysis, there was an 8% increase in productivity, which contributed to their return on invested capital (ROIC). Moving forward, we will proceed with a more detailed analysis to identify the factors behind the rise in profitability and productivity. When analyzing the income statement, three key drivers of operating margin were found: gross margin (also known as gross profit), selling general & administrative expenses, and depreciation. The formula for calculating operating margin is gross profit minus selling general & administrative expenses minus depreciation. It is worth noting that MCD experienced a significant increase in its gross profit, which played a major role in improving its operating margin. Specifically, over a 5-year period, the gross profit rose by 122%, climbing from 27.8% to 61.9%.
MCD’s ability to expand the spread, which refers to the difference between the price and cost of their product/services, indicates pricing power. This means that during a recession, MCD was able to achieve a higher price relative to the cost. However, MCD experienced an increase in overhead from -2.3% to 25.1%. Depreciation remained relatively stable at 5.3% changing only slightly to 5.2%. Taking into account productivity impact, the balance sheet can be divided into three parts: Op WC/Sales, PPE/Sales, and Intangibles/Sales.
By combining the three mentioned figures – invested capital sales, MCD’s op wc (operating working capital), and PPE/Sales (property, plant, and equipment to sales ratio) – we can observe that MCD is spending the same on Op Wc as before. However, their PPE/Sales has decreased by 8.2%, indicating a decrease in spending on PPE per dollar of sales. Additionally, their Intangibles/Sales has decreased by 2.7% from $.10 to $.098 per dollar of sales. Overall, we can conclude that the main factor contributing to the increase in productivity was the drop in PPE/Sales ratio, partially supported by the decrease in intangibles/sales ratio and unaffected by op wc/sales ratio.
To sum up, the rise of 45.3% in McDonald’s ROIC is due to three key elements: a reduced cash tax rate, a heightened operating margin, and improved productivity. The heightened operating margin is primarily influenced by a substantial 122% surge in gross margin. Furthermore, the increase in productivity can be attributed to a decline in PPE/Sales, indicating that McDonald’s is utilizing its facilities more effectively. When conducting an industry comparison through multiple analysis with McDonald’s,
We decided to concentrate on the Enterprise value ratios as they provide insight into how the companies perform in relation to the key value drivers discussed in class, such as the companies’ cost of capital, ROIC, and long-term growth prospects. When selecting which enterprise value ratios to use, we specifically considered the EV/EBIT and EV/EBITDA ratios for years one and two. These ratios are based on the company’s earnings, making them more practical for assessing a company’s free cash flow compared to the EV/Sales ratio, which solely considers revenue.
Ratio| AVG| MCD US| EV / EBITDA 1| 10. 34| 9. 89| EV / EBITDA 2| 9. 41| 9. 37| EV / EBIT 1| 14. 15| 11. 56| EV / EBIT 2| 12. 48| 10. 85|
Looking at McDonalds EV/EBIT and EV/EBITDA ratios, they are slightly lower than the industry average. We analyzed the three value drivers to understand the reasons behind this difference and evaluated how McDonalds performs in terms of Enterprise Value compared to its peers using these variables.
The company’s cost of capital is a crucial factor that considers McDonalds’ similarity to the average industry in terms of its WACC. Differences in enterprise value ratios can be traced back to differences in either ROIC or Long Term Growth potential. To assess the long-term growth prospects of McDonalds and its peers, we analyzed their individual long-term growth rates. McDonald’s disclosed a long term growth rate of 9.63%, which is considerably lower (34%) than the industry average of 14.6%.
The reason for McDonalds having a significantly lower number compared to its industry peers can likely be attributed to its dominance in the market. McDonalds is the largest company compared to its competitors, such as Yum Brands and Starbucks, with the combined market value of these two firms not surpassing that of McDonalds. As companies grow larger, sustaining growth becomes more challenging, which explains why McDonalds has lower growth prospects compared to its industry competitors.
The lower long-term growth rate of McDonald’s compared to its competitors contributes to its lower enterprise value ratios. To assess the impact of long-term growth on its enterprise value ratio, we analyzed the PEG ratio, a crucial indicator of ROIC, to compare McDonald’s performance with its industry peers. McDonald’s PEG ratio, obtained by dividing its P/E ratio by its growth rate, is significantly better than that of its industry peers.
McDonald’s has a higher PEG ratio of 1.70 compared to the average competitor’s ratio of 1.50. This indicates that McDonald’s has a superior ROIC and investors are willing to pay more for its earnings than they would for its competitors. Additionally, McDonald’s lower enterprise value compared to its competitors can be attributed to its significantly lower long-term growth rate, as its PEG ratio is higher than the industry average.
McDonald’s has a lower long-term growth rate (LTG) compared to its competitors, but it compensates for this with a higher return on invested capital (ROIC). The ROIC helps determine the enterprise value of a company. The price to book ratio measures the market value of equity compared to its book value, indicating whether a company has created value for shareholders. McDonald’s has a P/B ratio of 6.29, indicating value creation and a likely positive spread between ROIC and the weighted average cost of capital (WACC). However, when comparing McDonald’s P/B ratio to that of its competitors, it stands at 5.
McDonald’s has a slightly higher P/B average compared to its peers. This small lead may be because of its lower growth rate as indicated by its LTG rate of 9.63, while the average peer growth is 14.67. Despite McDonald’s higher PEG ratio of 1.70, suggesting a higher ROIC, its EV/EBITDA and EV/EBIT are lower than the average. This indicates a market perception that McDonald’s future ROIC and growth will be lower than its peers. Comparing specifically to competitors Yum Brands and Wendys, they have P/B ratios on opposite ends of the spectrum.
The P/B ratio of Yum Brands, which is 13.80, is more than double that of McDonald’s. This high price to book ratio is a result of Yum’s EV/EBITDA of 11.12, EV/EBIT of 14.06, and PEG of 1.71 – all of which are higher than both McDonald’s and the average. Therefore, the market expects Yum to have a favorable future spread between ROIC and WACC. Additionally, Yum’s P/E ratio of 20.49 and LTG of 12 are lower than average but still higher than McDonald’s. On the other hand, Wendy’s P/B ratio of 0.92 indicates that the company actually destroyed value. However, the analysis of Wendy’s is slightly less clear-cut compared to MCD and YUM.
The multiples for Wendy’s (EV/EBIT, P/E, LTG, and PEG) are all higher than those of McDonald’s and the average. This suggests that Wendy’s may have a stronger return on invested capital (ROIC). However, Wendy’s EV/Sales and EV/EBITDA are significantly lower than the average and McDonald’s. This indicates that the market does not expect Wendy’s sales growth to result in future ROIC growth. We analyzed leading indicators in the economy, industry, and company to determine the key drivers justifying a current share price of $87 as of last week.
The DCF valuation AS IS was based on the general consensus for years 2013-2014 sourced from Bloomberg. In 2012, sales were 27,488 and operating income was 8,478, while in 2013 sales were 28,944 and operating income was 8,949. This indicated a projected revenue growth of 1.8% and 5.3% for years 2012-2013 respectively, along with a cost of revenue of 38.9% and 38.8% for those years. From 2014-2022, the key factors used to determine our current market value were the revenue growth rate, cost of revenue, and taxes.
Our hypothesis is that McDonald’s will experience a conservative yet positive growth rate of 2%. Despite being in a saturated market and facing an uncertain economic outlook, we maintain our optimism regarding its global expansion and store implementation. We have selected a cost of goods sold of 47.8%, slightly below average, as McDonald’s benefits from lean production costs. It is worth noting that McDonald’s only owns approximately 20% of its stores, and as they franchise out more, their profit margins increase while their economies of scale improve, resulting in a reduction in their cost of goods sold.
Lastly, we modified the tax rate to 31%, which is simply an average of the past 6 years. All the strategies I implemented were aimed at achieving the current share price of 86.97. The next step in the valuation process involved projecting a future share price based on our own assumptions, so that we could provide a recommendation to either buy, hold, or sell the company. After reevaluating, we grew more optimistic about the revenue growth rate. This was influenced by our realization that McDonald’s intends to expand into countries with emerging markets and growing populations. Additionally, considering that 65% of its revenues are generated overseas, we decided to be slightly less cautious and increased our level of confidence.
The growth rate has increased to 2.7% from 2%, aligning with the US GDP growth rate. The growth is justified by the introduction of healthier food items and the successful McCafe coffee, which generates a billion dollars annually. We anticipate that these products will perform well both domestically and internationally. Furthermore, upon reevaluating the profit margins, we recognized that since 80% of the stores are franchised, the company incurs minimal costs. As McDonald’s expands its presence in emerging countries, the marginal cost will decrease due to economies of scale, as mentioned earlier.
Increasing bargaining power with suppliers will result in lower costs. Additionally, tax rates have been raised from an average of 31% to 35%. With Obama in office, it is likely that corporate and dividend tax rates will be increased regardless of whether the fiscal cliff issue is resolved. The percentage of net fixed assets as a portion of revenues has also risen from 84.6% to 92% due to the need for additional PP&E for expansion overseas. After incorporating these new assumptions, we have determined through the DCF valuation that our estimated share price is $100.42, which is higher than the current price of $86.
94, a 15. 5% increase, shows that the stock is beyond the 10% threshold, indicating a strong recommendation to buy the stock. Additionally, we arrived at a share price of $100.42 using economic profit valuation. To calculate this, we started with the operating value and added excess cash, non-operating assets, and subtracted non-operating liabilities to arrive at the enterprise value. Deducting the debt of $12,500 from this value gave us the equity value, which was then divided by the company’s outstanding shares to determine its price. The Roic at the final valuation is one of the most convincing reasons for our optimism towards this company.
Although McDonalds has not experienced significant domestic growth in a saturated market, it has recently demonstrated a higher return on invested capital (ROIC) compared to its competitors. This can largely be attributed to its larger amount of invested capital. Over the past few years, its ROIC has been increasing and reaching around 24%, primarily driven by growth in market share, dividends, and profit margins. Moving forward for the next decade, the ROIC projection indicates a consistent and reliable trend without any unusual fluctuations. The projected ROIC reverts back to the average of 18.5%, slightly higher than our current ROIC of 16.
Although McDonald’s return on invested capital (ROIC) is slightly below the industry average of 5%, it is important to note that McDonald’s weighted average cost of capital (WACC) is 6.5%, compared to the industry average of 7.5%. This means that the spread between ROIC and WACC is higher for McDonald’s. Additionally, McDonald’s invested capital is greater than that of most companies, which further justifies our analysis and price evaluation.
Another reason for recommending McDonald’s as a buy is its comparative multiples. When comparing the ratios, we can see that McDonald’s has above average enterprise value to EBITDA (Ev/Ebitda) and enterprise value to sales (Ev/Sales) for the next two years, when compared to the as-is model.
The P/E ratios increased from 15 to 21.87 after evaluation for the next two years. These ratios suggest that the stock price is being discounted excessively, leading to undervaluation. It is expected that the price will eventually return to higher multiples. We are not anticipating a decline in earnings, so an increase in multiples indicates a future rise in the stock price once it reverts to the average. Despite having lower long-term growth compared to its peers, investors are still willing to pay higher multiples due to its higher relative ROIC. This further confirms why the current share price is undervalued and supports our thesis.
