This week we look at McDonald’s Corporation (NYSE:MCD). With a market cap of over USD $93 billion and some 33,510 fast food outlets in 119 countries. The company has recently announced that it will open two vegetarian outlets in India and that it will be providing calorie information on its menu items. In New York City it already does so, as required by the law. McDonald’s menu makeover includes a new Egg White Delight and various fruit offerings. The company has also made statements regarding its commitment to sustainability and environmental responsibility. CapitalCube evaluates just how the market views McDonald’s Corp. based on the numbers.
Our analysis of the world’s largest fast food chain is peer-based and includes the ubiquitous Starbucks which boasts over 19,000 stores and Wendy’s. The full list of peers used in this analysis: Starbucks Corporation (NASDAQ:SBUX), Yum! Brands, Inc. (NYSE:YUM), Chipotle Mexican Grill, Inc. (NYSE:CMG), Tim Hortons Inc. (NYSE:THI), Darden Restaurants, Inc. (NYSE:DRI), Whitbread plc (LON:WTB), Panera Bread Co. (NASDAQ:PNRA), Brinker International, Inc. (NYSE:EAT), The Wendy’s Company (NASDAQ:WEN), Cracker Barrel Old Country Store, Inc. (NASDAQ:CBRL).
McDonald’s Corp.’s current Price/Book of 6.6 is about median in its peer group.
Valuation Drivers
MCD-US’s operating performance is relatively good compared to its peers. The market currently does not expect high earnings growth relative to its peers but seems to expect the company to maintain its relatively high rates of return.
Operations Diagnostic
Margin Driven
MCD-US’s relatively high profit margins are burdened by relative asset inefficiency.
Earnings Leverage
Changes in the company’s annual revenue and earnings are around the median among its peers.
Sustainability of Returns
Over the last five years, MCD-US’s return on assets has declined from above median to about median among its peers, indicating declining relative operating performance.
Drivers of Margin
The company’s relatively high pre-tax margin suggests tight control on operating costs versus peers.
Growth Expectations
MCD-US’s revenue growth in recent years and current PE ratio are both around their respective peer medians suggesting that historical performance and long-term growth expectations for the company are largely in sync.
Capital Investment Strategy
The company’s capital investment seems appropriate for a business with peer median returns.
Leverage & Liquidity
Quick and Able
MCD-US has the financial and operating capacity to borrow quickly.
Share Price Performance
Relative underperformance over the last year has improved more recently.
MCD-US’s share price performance of 5.7% over the last 12 months is below its peer median. However, its 30-day trend of 4.1% is now around the peer median suggesting that the company’s recent performance has improved relative to peers.
Price/Book or P/B valuation is a function of the observed operating performance of the company as measured by ROE multiplied by the market’s current implied growth expectation as measured by the P/E. We define Valuation Premium as the difference between the Market Capitalization and Book Value of Equity, and as a proxy for the NPV of cash-flow associated to the Book Equity investment.
Based on the analysis of the relative contribution to the P/B valuation of “Operations ROE” vs. “Expectations P/E”, we quickly garner insight into peers comparative performance and the market’s assessment of their strategies – are they just “Harvesting” the current business pipeline or are investors betting on a strategic “Turnaround”?
The market seems to expect MCD-US to maintain its relatively high returns.
MCD-US’s relatively high profit margins are burdened by relative asset inefficiency.
The company’s relatively high profit margins (currently 20.0% vs. peer median of 10.4%) are burdened by asset inefficiency with asset turns of 0.8x compared to the peer median of 1.5x. Overall, this suggests a margin driven operating model relative to its peers.
MCD-US has maintained its Margin Driven profile from the recent year-end.
MCD-US’s net margin continues to trend downward but is still within one standard deviation above its five-year average net margin of 17.9%. Though its net margin has remained relatively stable at 20.0% compared to 2011, its peer median has increased to 10.4% from 9.5% during this period. Net margin fell 1.3 percentage points relative to peers.
MCD-US’s asset turnover is similar to last year’s high of 0.8, which compares to a low of 0.8 in 2010. Compared to 2011, asset turnover has remained relatively stable for both the company (0.8) and the peer median (1.5). Overall, asset turnover and net margin trends suggest that MCD-US’s ROA at 16.6% is similar to last year’s high of 16.9%, which compares to a low of 8.0% in 2007.
Earnings Leverage
Changes in revenue and earnings are around the median among its peers.
Relative to peers, recent returns have declined versus last five years.
MCD-US’s current return on assets is around peer median (16.6% vs. peer median 14.6%). This contrasts with its higher than peer median return on assets over the past five years (14.3% vs. peer median 11.4%), suggesting that the company’s relative operating performance has declined.
Drivers of Margin
Relatively high pre-tax margin suggests tight control on operating costs versus peers.
The company’s gross margin of 44.8% is around peer median suggesting that MCD-US’s operations do not benefit from any differentiating pricing advantage. However, MCD-US’s pre-tax margin is more than the peer median (29.2% compared to 14.5%) suggesting relatively tight control on operating costs.
MCD-US has maintained its relatively high pre-tax margin profile from the recent year-end.
MCD-US’s gross margin is greater than (but within one standard deviation of) its five-year average gross margin of 43.2%. Though its gross margin has remained relatively stable at 44.8% compared to 2011, its peer median has decreased to 37.4% from 43.5% during this period. Gross margin rose 6.2 percentage points relative to peers.
MCD-US’s pre-tax margin is its highest relative to the last five years and compares to a low of 15.2% in 2007. Though its pre-tax margin has remained relatively stable at 29.2% compared to 2011, its peer median has increased to 14.5% from 12.8% during this period. Relative to peers, pre-tax margin fell 1.6 percentage points.
Growth Expectations
Historical performance and long-term growth expectations for the company are largely in sync.
Detailed tables on Key Valuation Items, Revenues & Margins, Key Assets (% of Revenues), Key Working Capital Items, Cash Management Indicators, Key Liquidity Items, Key Cash Flow Items (% of Revenues) are available on logging in.
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This article was written by abha.dawesar, and posted on Capital Cube.
Warren Buffett never mentions this but he is one of the first hedge fund managers who unlocked the secrets of successful stock market investing. He launched his hedge fund in 1956 with $105,100 in seed capital. Back then they weren’t called hedge funds, they were called “partnerships”. Warren Buffett took 25% of all returns in excess of 6 percent.
For example S&P 500 Index returned 43.4% in 1958. If Warren Buffett’s hedge fund didn’t generate any outperformance (i.e. secretly invested like a closet index fund), Warren Buffett would have pocketed a quarter of the 37.4% excess return. That would have been 9.35% in hedge fund “fees”.
Actually Warren Buffett failed to beat the S&P 500 Index in 1958, returned only 40.9% and pocketed 8.7 percentage of it as “fees”. His investors didn’t mind that he underperformed the market in 1958 because he beat the market by a large margin in 1957. That year Buffett’s hedge fund returned 10.4% and Buffett took only 1.1 percentage points of that as “fees”. S&P 500 Index lost 10.8% in 1957, so Buffett’s investors actually thrilled to beat the market by 20.1 percentage points in 1957.
Between 1957 and 1966 Warren Buffett’s hedge fund returned 23.5% annually after deducting Warren Buffett’s 5.5 percentage point annual fees. S&P 500 Index generated an average annual compounded return of only 9.2% during the same 10-year period. An investor who invested $10,000 in Warren Buffett’s hedge fund at the beginning of 1957 saw his capital turn into $103,000 before fees and $64,100 after fees (this means Warren Buffett made more than $36,000 in fees from this investor).
As you can guess, Warren Buffett’s #1 wealth building strategy is to generate high returns in the 20% to 30% range.
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