Intrinsic Value Assessment of

MCDONALD’S (MCD)

October 9, 2017 This article was written in collaboration with Eoin O'Byrne

a friend of The Investor’s Podcast

ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.

IntroductionMcDonald'sisanemployerof350,000peopleandserves68millionpeopledailyacross119countries.TheserestaurantsareeitherownedbyMcDonald'sorarefranchisedrestaurants;thiscanbebothpositiveandnegativetotheGoldenArchesbrandasweexplorelater.

Franchisingisresponsibleforoperatingover80%ofthebranchesandis,therefore,creatingastrongflowofcapitalforthecorporation.AsMcDonald'sownsallofthelandsonwhichtherestaurantsareestablished,ithasavastrealestateempireandthis,marriedwithco-investmentfromfranchisees,hasledtooneofthemostsuccessfulfranchisesintheworldeconomy.In2014,ofthetotal$1.2trillioninsalesgeneratedbyalltheworlds‘InformalEatingOut’(IEO)Segment,McDonald's,whichaccountsfor0.5%ofallIEO’sglobally,generated7.2%ofsales.

Whenthissectorisexpandedtoincludeallrestaurants,McDonald’smarketpresenceis0.2%,andyetitaccountsfor3.6%ofsalesinthemarketof$2.4trillionsales.Aswecanseefromtheaboveperformance,McDonald’sisasignificantfixtureintheglobaleaterymarketplace.

MCD’sIntrinsicValue

McDonald'shasaconsistentfreecashflowwhichallowshighrankingmembersofthecorporationtoreinvestthemoneyintothecompanythroughexpansionintoothermarketplaces.Aswecansee,theFCFhasgrown70%ofthetimeoverthelastdecade.Thisindicatesthatthecompanyhasbeenrunwithcontrolledspendingandpositiveincomeflowsgeneratedfromitsfranchiseincome.WeliketoseethislevelofcontinuedFCFgrowthasitshowsacompetentmanagementisinplaceandcancontrolboththeinflowsandoutflowsofthecorporation.

Intrinsic Value Assessment of

MCDONALD’S (MCD)

ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.

Below,wecanseethe10-yearprojectedfreecashflowforMcDonald'swiththreeprojectedfutureFCFbandscontaininganUpper(5%growth),Middle(2%growth),andLower(-2%growth).Iselectedtheupperbandbyjudgingthesizeofthecompanyandhowmuchpotentialforgrowththereis.Withthecompanybeingsoglobalized,thereislittleroomforexpansion.Therefore,thelevelofgrowthachievedisunlikelytogrowatanysignificantratesorevenmoresignificantthanithasoverthepastdecadewhichhasbeen4.5%.Themiddlebandwasselectedonasimilarprincipletotheupperband;aboutsuchpastlevelsofgrowthbeingimprobabletoreplicate.Thelowerbandusesnegativegrowthalsoatsuchalowlevelinspiteofthecompany’slackofroomtoexpandasitreceivessuchahealthystipendthroughfranchiserevenue.TheIRRwhichwillbegeneratedbasedonmycalculationswillbe1.3%thislevelofreturnisinlinewiththeyieldonUST-Billswhichoncefactoredforinflationgeneratesjustbelow1%.

Thelevelofdividendspaymentsoverthelastdecadehavebeenbetween$2and$4ashare.Thispayoutratioforthesedividendshasbeenquitehighoverthelastfewyearsbetween60-70%.Thislevelofpayoutislargeandissomethingwhichthecompanycankeepprovidingastheyaremorethanlikelynotgoingtoexpandovertheforeseeablefuture.

Also,anyrepercussionsinreducingthedividendwillgreatlyoutweighanyminimalgrowthachievedbyexpansion.Thislevelofpaymentmaybeduetothelowlevelsofreturnotherwisegeneratedbythestockandisthecompany’swayofrewardingstockholders.

MCD’sCompetitiveAdvantageAmajormoatthatMcDonald'spossessesisitsname;thenameissynonymouswithtastyfastfoodandgoodtimes.Thisideaismostnotedinthe“HappyMeal”-achild’smealthatcomeswithatoyandisthehighlightofmanychildren’soutingsandadult’schildhoodmemories.McDonald'skeepsthisnostalgicandfamilyelementofthefranchisethroughoutthemajorityofmarketingcampaignsandfoodofferings,whilealwaysprojectingthatimageandassociationwiththeMcDonald'sname.ThisoneoptionontheMcDonald'smenuaccountsforjustunder15%ofallordersintherestaurantandisresponsibleforgenerating$10,000,000dailyforthecorporationworldwide.

Asmentionedintheintrinsicvaluesectionofthisanalysis,McDonald'shasbeenpayingquiteahighamountofdividends.This40-yearhistoryofpayingadividendshowsthatthecompanyhasthemeansandthe

Intrinsic Value Assessment of

MCDONALD’S (MCD)

ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.

wherewithaltocontinuepayingasthecompanygeneratesitssignificantincomethroughsteadyfranchisingchannels.Thisisnotedinthecompany’shighcoverageratiowhichcurrentlystandsat9.94.Thisratioindicatestheabilityofthecompanytoserviceitsdebt.Currently,McDonald'shasanoperatingincomeof$2,295million,andtheirInterestExpenseresidespresentlyat-$231million.

SmallTop5ownershipstakeat7.8%meansnoindividualstockholderisexertingundueinfluenceandpowertoblockthecompanyfromtakingactionswhichtheshareholdermaynotwantasitdoesnotgenerateshort-termrewards.Thefranchisemodelgeneratespositivecashinflows.ThislevelofsteadyrevenuegeneratedthroughaminimaleffortbytheMcDonald'sCorporationthroughitsfranchiseesisnotmatchedbyanyothercompetitor.Moreso,the80%ofMcDonalds’restaurantsarefranchises,andtheserestaurantspayaninitialfeeof$45,000aswellas4%annuallyonprofits.Thiscontinuouspositivecashflowisessentialtothecorporation’sprofitability.

RisksAnegativehealthimageandfoodsafetyconcernsaretwoofthemajorissuesoutlinedinMcDonald's10Kfilings.ThisassociationwithfastfoodandanunhealthylifestylemaybedangerousforthecompanyasfewerpeoplemayvisitaMcDonald'slocationand,instead,optforhealthieroptionslikejuicebars.McDonald'shastriedtobettertheirmenusbyofferingsaladsandprovidingfruitsnacksinsidechildren’sHappyMeals.Thecurrentphenomenondevelopedbymillennialstocreatefoodtrendsthroughsocialmediahasbeennotedbymanybrandsandhascausedcompaniestoreactquicklybyadaptingandreinventingproductstomeetever-changingconsumerdemandswhiletryingtoavoidlosses.ThischangeintrendissomethingMcDonald'sneedstobeevervigilantofandadaptwherenecessary.

Althoughthefranchisemodeldoesworkforthem,itcancausesignificantheadachesfortheboardandthecompany'simage.ThereisonlylimitedcontrolexercisedbyMcDonald'soveritsfranchisees,andthislimitedpowercanresultinincidentswherethebrandiscalledintodisrepute.ThiswasmostnotablyseeninIndiawhen44restaurantswereclosedafterMcDonald'srefusedtorenewthelicensesonthechainsrunbyVikramBakshiasthelevelandstandardofthesebrancheswerenotinkeepingwiththeimagetheMcDonald'swishedtoportray.Thisresultedin80%oftherestaurantsinDelhibeingclosedandasignificanthurdletoovercomeforthecompanyintheIndiancapital.

OpportunityCostsAswearecurrentlyinoneofthelongest-runningbullmarkets,wemustanticipatethatadownturnintheeconomyisincreasinglylikelywitheverynewhighthatisreachedontheS&P500andNASDAQ.Thislevelofconstantgrowthandaccelerationisalltoohigh,andwenotethiswiththeSchillerP/Eat31.11.Thislevelissimilartothatof1998justbeforethedotcomcrash.ThislevelofpremiumpricingfortheS&P500isalsoseeninthelowyieldfromU.S.stocksastheycurrentlyyieldlittlemorethe3%(1/31.11)withoutaconstantdividendstream,whichMcDonald’sstockoffers.AlthoughMcDonald'smayreturnlesscomparedtotheS&P500,thelargeoverpricingoftheS&Pmeansthereisahigherlikelihoodofareadjustmentandthereforethelikelytofallinprice.

MarketConditionsTheoverallglobalpresenceofthefranchiseissomethingthatkeepsthemasaleaderinthefranchisefield.BurgerKingrecentlyarguedtostopfurtherviewingsofthemovieITinRussiaasthelikenessofRonaldMcDonald,theMcDonald'smascot,andtheleadantagonistinthefilmwasagiantadvertfortheGoldenArchesfranchise.ThisemphasizesthemagnitudeofMcDonald'sthataleadingcompetitorhasattemptedforablockbustermovietobebannedbecausethereisaclowninthefilm.TheglobalpresenceofMcDonald's,whichisamajorstrengthofthecorporation,isalsoanareaofweaknessforthem.

Intrinsic Value Assessment of

MCDONALD’S (MCD)

ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.

Thislevelofpresencein119countriesalsomeanstheyareexposedto119differenteconomicandsocio-economicsituations.ThisrangesfrompooreducationleadingtolowerincomesandthereforelessdisposableincometobespentinlocationsorpotentiallyafinancialcrashinsomeeconomiesthatmaycauseaseverereductionintheamountofcashflowingintotheeconomycausingallsortsofuntoldtroubleforMcDonald'sfromlowerpropertypriceswhichaffectthelocationsthatmayneedtobesoldinordertogenerateincomeorevenlessmoneyreceivedfromfranchisingchannelsasdiminishingforeignexchangerateserodeprofitsbeinggenerated.

SummaryHavingtakenalltheaboveintoaccount,McDonald's,atitscurrentpricemayonlyyield1.3%.Thisisanexampleofagreatcompany,withstablecashflows,thatlikesomanyotherstocksatthemomentispricedunattractively.Oneargumentcouldbemadefortheincomeinvestortocollectthedividendsafely,currentlyyielding2.3%whichislikelydownsideprotected,andwillgraduallyincrease.However,forthevastmajorityofinvestorsandincludingmorepatientincomeinvestors,McDonald'sshouldbeavoidedatthecurrentpricelevel.

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