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McDonald's: Is a real estate company and not a food company.

Opdateret: 26. apr.


Former McDonald's CFO Harry J. Sonneborn is quoted as saying, "We are not technically in the food business." "We are in the real estate business," when explaining the business of McDonald's. While McDonald's current CEO, Chris Kempczinski, has said, "We are in the business of selling a brand so that others can sell burgers and fries." Thus, viewing McDonald's solely as a burger and fries restaurant does not provide an accurate representation of the business. In this analysis, I will investigate the company to determine if now is the right time to buy the stock.


This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.


Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.


For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares in McDonald's. If you would like to view the stocks in my portfolio or if you are interested in copying my portfolio, you can find instructions on how to do so here. I don't own any stocks in McDonald's competitors either. As always, I will keep this analysis unbiased. If you want to purchase shares or fractional shares of McDonald's, you can do so through eToro. eToro is very user-friendly and easy to get started with. You can start with as little as $50. Click on the picture below to get started.



McDonald's was founded in California, USA in 1940, and it all started with one restaurant. They now have around 40.000 restaurants in 119 different countries. Since its foundation, the business has evolved, with only a few (5%) of the restaurants being owned by McDonald's, while the rest are franchised. To fully understand the business of McDonald's, you need to comprehend that there are two different ways in which the restaurants can be franchised. The first type is a conventional franchise, where McDonald's either owns or secures a long-term lease on the land and constructs the restaurant. The franchisee is responsible for covering the costs of equipment, signs, seating, and decor. Once the conventional franchise is operational, McDonald's receives fees from the franchise based on various factors. The second option is a development license or affiliate agreement, where McDonald's does not invest any capital but receives initial fees and royalties based on sales. The business structure of McDonald's means that they are not only the largest restaurant chain in the world, but also one of the largest real estate companies in the world. Thus, McDonald's generates revenue through sales from company-operated restaurants, as well as fees and royalties from franchises. With the multitude of restaurants worldwide and its highly recognizable brand, it is evident that McDonald's possesses a substantial brand moat. CEO Chris Kempczinski has further elaborated on their brand strengths by mentioning that the Big Mac, McNuggets, and McFlurry are billion-dollar brands in their own right. The Economist also introduced The Big Mac Index in 1986, a currency comparison tool named after the popular fast-food item.


The CEO is Chris Kempczinski. He joined McDonald's global strategy team in 2015 and was promoted to President of McDonald's USA in just one year and one month. He became the CEO of McDonald's in 2019 after the former CEO, Steve Easterbrook, was removed from his position. He has a bachelor's degree from Duke University and an MBA from Harvard Business School. Prior to joining McDonald's, he held positions at Procter & Gamble, PepsiCo, and Kraft Foods. He faced a challenging start with the sudden departure of the previous CEO and the onset of a pandemic shortly after. The second quarter of 2020 was the worst quarter in McDonald's history, but it did not deter Chris Kempczinski. By the fourth quarter of 2020, they had fully recovered their sales to match those of the fourth quarter of 2019. Since becoming CEO, he has developed a growth strategy called MCD. M stands for "Maximize our Marketing," C stands for "Commit to the Core," and D stands for "Double Down on the Three Ds" (Digital, Delivery, and Drive Thru). This strategy is believed to lead to long-term growth for McDonald's. He is known to be a very detailed and analytics-oriented executive, which may be a problem in such a broad leadership role. However, I read an interview with him, and I liked some of the things he has learned through the pandemic. One thing he mentioned is that there is no such thing as overcommunicating. In a survey at the end of 2020, 90% of employees said they felt well supported by the leadership during the pandemic, which is a great number. When asked if there are any companies he admires, he mentions Amazon for their Day 1 orientation, Nike for engaging their customers and keeping the brand relevant, and Walmart for being engaged with their associates to address questions about the corporate brand. Overall, I am confident that Chris Kempczinski is the right person to lead McDonald's into the future.


I believe that McDonald's has a strong brand moat. I feel confident that Chris Kempczinski is the right person to lead McDonald's growth. Now, let us investigate the numbers to see if McDonald's does live up to our requirements for a strong moat. In case you want an explanation about what the numbers represent, you can refer to "MY STRATEGY" on the website.


The first number we will investigate is the return on invested capital, also known as ROIC. We want to see a 10-year history, with all numbers exceeding 10% in each year. These numbers are certainly encouraging as McDonald's has consistently achieved a ROIC well above 10% in all years. They even managed to maintain a ROIC (Return on Invested Capital) above 10% during 2020, a year when most countries experienced periods of lockdowns. Excluding 2020, McDonald's has managed to deliver a Return on Invested Capital (ROIC) above 20% every year, which is encouraging. McDonald's has achieved its highest Return on Invested Capital (ROIC) in two out of the last three years, and it is particularly encouraging to note that McDonald's achieved its highest ROIC in 2023.



The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. It is curious that McDonald's has had negative equity since 2017. The reason for this is that McDonald's has used low-cost debt to buy back shares. It might make sense if the stock is significantly undervalued and the debt has a low interest rate. Since interest rates have increased, McDonald's has reduced its reliance on debt to repurchase shares. This shift has led to an increase in equity from 2022 to 2023, even though it remains negative.



Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins offer a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is not surprising that McDonald's has generated a positive free cash flow every year over the past decade. It is encouraging that McDonald's has achieved its highest free cash flow in two out of the past three years, with 2023 marking the year with the highest free cash flow. Levered free cash flow margin has been above 20% since 2019, which is another encouraging sign. McDonald's achieved its highest levered free cash flow margin in 2021. Although the margin did not reach that level in 2023, it still marked the second-highest levered free cash flow margin in the past two years, indicating positive development. Free cash flow yield is currently at its highest level since 2016. This may suggest that McDonald's is trading at lower multiples than it has in some time. However, we will delve deeper into valuation later in the analysis.



Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a period of 3 years. We do this by dividing the total long-term debt by earnings. Upon calculating McDonald's financials, I have determined that McDonald's has 4,39 years of earnings in debt. It is more than I would like to see, but not surprisingly, as McDonald's has used debt to buy back shares. While it won't prevent me from investing in McDonald's, it is something worth monitoring.



Based on my preliminary findings, I believe that McDonald's is an intriguing company. However, no investments are without risk, and McDonald's also has some risks. One risk is macroeconomics. McDonald's financial performance is significantly influenced by economic conditions, such as inflationary pressures, which can vary greatly by market and affect consumer disposable income levels and spending patterns. Management has mentioned that they see pressure with the U.S. low-income consumer. They mentioned that they have experienced a reduction in transaction size among low-income consumers, indicating that they purchase less when visiting McDonald's. Management has mentioned that these headwinds will persist as the current macro dynamics continue to impact their consumers. Management believes that high absolute prices and low consumer confidence will cause their customers to continue being more selective with their spending. Another risk is competition. In its annual report, McDonald's mentions that they face sustained, intense competition from traditional fast-casual and other competitors, which may include many non-traditional market participants such as convenience stores, grocery stores, coffee shops, and online retailers. We expect our environment to remain highly competitive. Especially, grocery stores have become strong competitors. Management mentioned that the informal eating out (IEO) industry has experienced a decrease because eating at home has become more affordable. There has been much less price fluctuation recently in packaged food. As eating at home becomes more affordable, management believes that this trend has put pressure on the IEO industry, as low-income consumers are opting to eat at home on a larger scale. Labor challenges. McDonald's success depends, in part, on its ability to effectively attract, recruit, develop, motivate, and retain qualified individuals to work in McDonald's restaurants and to maintain appropriately staffed restaurants in an intensely competitive labor market. McDonald's and its franchisees have faced, and may continue to face, challenges in adequately staffing certain McDonald's restaurants, which can have a negative impact on operations. Furthermore, McDonald's has experienced increased costs and competition associated with attracting, recruiting, developing, motivating, and retaining qualified employees. Thus, if these challenges and elevated costs persist, they will affect McDonald's.


McDonald's also has a lot of potential for growth. New opportunities. McDonald's has established a new business ventures team intended to function as an entrepreneurial startup within the company. The team quickly identified an opportunity in a $100 billion category across McDonald's top six markets, which comprised beverage-led occasions. As a result, they opened a pilot CosMc's restaurant. Currently, CosMc's is only expected to conduct a 10-store test, but if successful, it would broaden McDonald's exposure to the high-margin coffee business. And it doesn't have to stop with CosMc's. Management has mentioned that the new business ventures team will identify opportunities and adopt new ways to surprise and delight their customers. The loyalty program. Loyalty programs incentivize customers to engage more with the brand, resulting in increased visit frequencies. McDonald's has established one of the largest loyalty programs globally in just a few years. McDonald's believes that it becomes even smarter with its pricing methodology and tailors its digital offers to its fans, making them even more personalized through the loyalty program. The loyalty program has more than 150 million users today, but that represents only a fraction of their total customers. McDonald's expanded its loyalty program to 50 markets worldwide and achieved over $20 billion in annual system-wide sales through its loyalty program in 2023. But there is still room to grow. McDonald's aims to reach 250 million active users and $45 billion in annual loyalty system-wide sales by the end of 2027. Growth in China. McDonald's has recently completed the acquisition of Carlyle's 28% stake in McDonald's China. Management has mentioned that they are excited to have increased their minority ownership to 48% in their second largest and fastest-growing market. They believe it will enable them to further benefit from the market's long-term potential. Management believes that consumer wealth and the continuous mid-single-digit growth of GDP in China will create long-term opportunities for them. McDonald's built 1.000 restaurants in China in 2023 and expects to build 1.000 more in 2024. They see an opportunity to further develop and expand their presence in the market to areas where McDonald's is not currently established.



Now it is time to calculate the share price of McDonald's. I perform three different calculations that I learned at a Phil Town seminar. The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 11,56, which is from the year 2023. I have selected a projected future EPS growth rate of 8%. Finbox expects EPS to grow by 7,8% in the next five years. Additionally, I have selected a projected future P/E ratio of 16, which is double the growth rate. This decision is based on McDonald's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $121,76. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy McDonald's at a price of $60,88 (or lower, obviously) if we use the Margin of Safety price.


The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 9.612, and capital expenditures were 2.357. I attempted to analyze their annual report in order to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 1.650 in our calculations. The tax provision was 2.053. We have 722,7 outstanding shares. Hence, the calculation will be as follows: (9.612 – 1.650 + 2.053) / 722,7 x 10 = $138,58 in Ten Cap price.


The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With McDonald's free cash flow per share at $10,00 and a growth rate of 8%, if you want to recoup your investment in 8 years, the Payback Time price is $120,21.


McDonald's is an interesting company with a strong brand moat. I also feel quite confident in the management. Macroeconomics will impact McDonald's, especially its low-income consumers, who are now ordering less per order than before. Competition will always be a risk for McDonald's as they operate in a highly competitive industry with many competitors. Currently, McDonald's and other companies in the informal dining sector are facing competition from grocery stores as eating at home has become more affordable recently. Finally, McDonald's is facing labor challenges. Attracting labor is more challenging and costly. McDonald's has launched CosMc's. While it is still uncertain how big CosMc's will grow, this move shows that McDonald's is exploring new opportunities. If successful in these new ventures, it could serve as a long-term growth catalyst. Another growth catalyst is their loyalty program, which has become one of the largest in the world. Even if McDonald's manages to reach 250 million active users and $45 billion in annual loyalty system-wide sales by the end of 2027, it probably won't stop there. This suggests that it could serve as another long-term growth catalyst. Finally, McDonald's is expecting to benefit from China as the middle class continues to grow, and McDonald's is currently underpenetrated in the market. McDonald's has recently made significant investments in China by opening 1.000 stores per year and acquiring Carlyle's 28% stake in McDonald's China. I like McDonald's business model and their outlook. However, I will need a discount if I am to buy shares. Thus, I will only buy shares in McDonald's if they reach the Ten Cap price of $138.


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I hope that you enjoyed my analysis. Unfortunately, I cannot do a post of all the companies I analyze. I am available to copy but if you do your own trades, you can follow me on Twitter instead, as I tweet when I buy or sell anything.


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