Why merge or acquire?
Companies typically acquire to realize economies of scale, scope, gain customers, bundle complementary products, or gain vertical integration. From an investor’s perspective, these business reasons fall into natural screening categories that include: (a) buying companies to boost growth expectations; (b) buying to realize cost synergies; and (c) buying earnings through acquisitions that increase EPS.
Potential targets would typically be smaller than their peers though sometimes targets can be marginally larger than the acquirer. As a result, when identifying a company as a target, we check for a book value that is up to 80% more than the peer median. In addition, we also filter for a cheap valuation relative to peers (i.e. price to book is less than the peer median) and a share price that is trading sufficiently (i.e. at least 20%) below its 52-week high.
Typically, acquirers are larger than their peers though, as mentioned above, targets can sometimes be marginally larger than the acquirer. To identify a company as an acquirer, we look for a book value that is around or more than the peer median and for growth expectations (measured by its price to earnings or P/E) that are lower than peer median. In addition, we consider whether the company has the capacity to add intangible assets (like goodwill) and whether its valuation (measured by its price to book or P/B) is attractive relative to its peers.
MCD-US could potentially acquire other companies within this peer group.
The market’s current relatively low growth expectations for MCD-US imply it would need acquisitions to grow. The company’s book value of USD14,035 million gives it the size to make acquisitions in this peer group. In addition, its comparatively low proportion of intangible assets suggest that the company has some room to acquire — even possibly using its equity which is currently trading at a higher price to book (P/B) relative to peers.
MCD-US’s large book value would make it difficult to acquire in this peer group.
MCD-US’s book value of USD14,035 million makes it one of the larger companies in this peer group and thus difficult to acquire.
Dividend cut, increase or initiate?
In this section, we try to identify whether the company is likely to cut, increase or initiate a common stock dividend. In order to screen for these actions, we apply multiple tests to check whether the combination of operating performance, leverage, liquidity, growth expectations and share price performance is sufficient to permit such an action.
To check for a dividend increase at MCD-US, we look for outperformance relative to its peers in terms of pre-tax margin and operating cash flow. In addition, we also filter for relatively low leverage and good liquidity, which indicates sufficient support for debt servicing. We also look for a price to book value (P/B) that is positive, relatively low growth expectations (based on P/E) and a share price that has underperformed its peers. Overall, these conditions suggest that there is pressure on management to return money to the shareholders in the form of a dividend in order to increase their total returns. Finally, we overlay the dividend quality (medium or high) and ending cash dividend coverage (moderate or strong) to indicate whether the company is likely to increase its dividend.
To check for a dividend cut at MCD-US, we look for underperformance relative to its peers in terms of pre-tax margin and operating cash flow. In addition, we filter for interest coverage that is somewhat tight, which combined with a low dividend quality and a weak ending cash cushion would suggest that a dividend cut is likely.
Fundamentals do not support a change in dividend policy in the near-term.
The combination of MCD-US’s operating performance and interest coverage does not seem to justify a dividend cut. In addition to margins and cash flow levels that are relatively good compared to peers, the company’s leverage and liquidity ratios suggest the company can easily service its current debt. The high dividend quality also supports a dividend increase. However, the company’s valuation, growth expectations and relative share price performance combined with a weak cash cushion (just 0.9x the cash dividend) do not seem to support a dividend increase.
Is the company likely to buy back shares?
In this section, we identify whether MCD-US is likely to buy back its shares. In order to screen for this event, we look for positive free cash flows and good liquidity in addition to a leverage, an earnings multiple and a current share price that are low enough to suggest that there is some pressure on management to buy back shares. If the company pays a dividend, we also confirm that its ending cash balance is more than the cash dividend in order to highlight the greater priority of paying a dividend versus buying back shares.
MCD-US’s share price performance does not justify a share buyback as the best use of cash.
MCD-US’s current share price is not sufficiently below its 52-week high (currently 10.3% lower) and does not justify a share buyback as the best use of cash at this time. As a reference, the company’s cash balance is currently 2.7% of its market capitalization.
McDonald’s Corp. operates and franchises McDonald’s restaurants in the global restaurant industry. The company manages its business as distinct geographic segments. Its significant reportable geographic segments include the United States, Europe, and Asia-Pacific, Middle East and Africa. The company operates in the global restaurant industry and manages its business as distinct geographic segments. It offers a substantially uniform menu, although there are geographic variations to suit local consumer preferences and tastes. McDonald’s menu includes hamburgers and cheeseburgers, Big Mac, Quarter Pounder with Cheese, Filet-O-Fish, several chicken sandwiches, Chicken McNuggets, Snack Wraps, French fries, salads, oatmeal, shakes, McFlurry desserts, sundaes, soft serve cones, pies, soft drinks, coffee, McCafÃ© beverages and other beverages. It was founded on April 15, 1955 by Raymond Albert Kroc and is headquartered in Oak Brook, IL.
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This article is written by abha.dawesar, and was originally posted on Capital Cube.