Second Eternal Yield Analysis online right now !

Overview
McDonald’s (ISIN: US5801351017)  franchises and operates fast-food restaurants. They serve meals with medium-priced food products in more than 100 countries worldwide. Due to their well-known brand and fully standardised serving experience, McDonald’s (MCD) is one of the worlds leading fast-food chains. A dividend yield of 3.4%, historical dividend growth rates above 20% and the worldwide highest income numbers are pointed out.

1. Leadership & Corporate Culture

• Board: (work in progress)
• Most day-to-day management done at local shops.
• Well-regulated and standardized working processes.
• High employee turnover, but new ones are instructed fast.
• No (academic) education for operative level needed.

Decentral managed MCD franchise restaurants with low qualified working force and high turnovers.

2. History & Status Quo

General:

• MCD usually owns land and building. Locally owned restaurant responsible for operating costs and day-to-day management. In most cases, franchise contracts are agreed upon a 20 year horizon, so cash flows contains one  very stable, predictable share.
• Stock buyback programs running. How high were those and planned volume (work in progress)?

Net income 2013:

• Sales made mainly by restaurants operated by MCD: 18.9 bn $ (68%).
• Payments from franchised stores as rent and royalty payments: 9.2 bn $ (32%).

Growth:

• Income growing and growing, see next graph.

• Sales growth higher compared to restaurants numbers growth.
• Very stable sales, even in 2009 only a slight dip.
• Approx. 3.5 bn $ adding net income over 13 years. From 1.98 bn $ in 2000 to the point of  5.58 bn $ in 2013. Results in 0.27 bn $ per annum or 8.3 % on average (geometrically determined).
• Growth comes from expanding in emerging markets, so that company growth based on rising (global) market share and not market growth. MCD growth is higher compared to worldwide population growth.
• All cash flows healthy.

Market environment:

• Easy market entry. Many competitors like Burger King, Subway or local shops.
• Market leader position given (measured by sales).

Debt:

• Equity-debt ratio at 43.71 %. That corresponds to 16 bn $ with a balance sheet total of 36.6 bn $.
• Medium, healthy debt usage.
• We would prefer a slightly lower equity ratio in order to diminish total capital expenses.

Dividends:

• 3.12$ dividends per share in 2013. Results in 3.14 bn $ payout (out of 5.58 bn $ net income).
• Payout ratio between 31 % (2004) and 76 % (2007). Today at 56% (2013). Always below 100 %, covered.
• Last 10 years: Stable dividend growth (dividends went up 10x).
• Dividends increased gradually since 1977 (included in S&P 500 dividend aristocrats).
• Dividends increased on average by approximately 20 % annually since 2010 calculated geometrically. Those are based on higher payout ratios and not higher incomes.

Income steadily growing. Even depressions producing just slight income dip. Dividends growing faster than income due to higher payout ratios.

3. Sustainable Core Competence

• Standardized, fast and cheap MCD restarurants opening. Customer loyalty given from day 1.
• Early break even and profitability checks of single restaurants.
• Extensive economies of scope – using same machines of several products.
• Forward integration with own stores.
• Omnipresent brand building e. g. driving lessons to MCD, children’s birthday parties, monopoly games, …
• Production (meat e.g.), processing and preparation are affected of regulatory initiatives. Any regulation that does not coincide with standard approaches will result in extra costs and ensures a minor risk.
• Further minor risk due to the control loss of franchisees. Things could go wrong, due to financial, operational or (online) promotional failures. Limited by narrow contracts.
• Minor risk within rising nutritional awareness.
• Small consumer switching costs, due to possibility to go to another fast food restaurant (e. g. Burger King). Therefore, huge dependency on customer brand trust, resulting in major risk.
• Resource costs like labour costs, commodity costs and occupancy costs sets directly net income. All those are changing and determined externally, wherein one further major risk can be located.

Core competence lies within standardization and fast cost-efficient restaurant build-ups. Competitive advantage given by worldwide well-known brand (like Coca Cola). Major risk can be seen within loosing brand trust and with rising resource costs.

4. Fair Price with Safety Margin

• Key business model: Standardized fast food chain with franchise labor-intensive business model in which most restaurants are operated and owned by MCD itself.
• World-wide operations, guide to high risk diversification within MCD itself.
  
• Well known brand and extensive marketing needed to hold brand sustainable.
• Earnings coming from both, B2C and B2B.
• Need directly included in Maslow’s pyramids lower layers and therefore food market need will never ends.

Derivation of assumptions for Net Present Value ():

• = Required long-term yield of 8%. Corresponds historical long-term stock yields in Europe/US. Plus safety margin, so we use 10%.
• = Eternal dividend growth. Should be in line with long-term net income growth. As shown net income growth were at 8.3%. Plus safety margin we obtain 6.3% dividend growth.
• = Dividends 2014. 3.12$ dividend per share in 2013. Added safety margin: 2013 dividend assumed for 2014.

Gordon Growth Model:

• Calculation in $
• =10%
• =6.3%
• =3.12$
• Price at approx. 94.25$ (18. August 2014)

With given long-term assumptions (incl. multiple safety margins) MCD is slightly overvalued.

Summary & Key Findings:

• Core competence: Standardized, fast and cheap restaurant build-ups.
• Competitive advantage given by worldwide well-known brand.
• Major risk can be seen within loosing brand trust and with rising resource costs.
• Always covered dividends, with above average growth rates.
• Defensive cash-cow company, stable sales and low income volatility.
• With given long-term assumptions this stock is overvalued.

Further Interesting Facts:

• Inside german investors circles currently no ‘sexy’ stock.
• Approach for worldwide inflation measurement: Big-Mac-Index (The Economist).
• Any promotional activities do not have universal appeals, so that among different customer segments there could be negative effects (seen worldwide).
• Quality assurance labs around the world, to make sure every product compliance to standards. All MCD burgers around the world should be similar (with some exceptions, due to e.g. religious reasons in India).
• MCD supports franchisees strongly via credits, courses of instruction and hotlines.
• Visitors feel home, even if they are abroad. Hence, many business man and travvelers go to MCD occasionally.

Further Sources for Evaluation:

Wikipedia Article
Yahoo Finance Sheet
Annual Report 2013

If you have any suggestions, comments, proposals or others please share your thoughts!