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McDonald’s (MCD)
Company Profile1
Investment Recommendation:
Moderate Buy
Target Price:
 Quarter…..$42.41
 Year……..$50.16
Pricing:
Closing Price
$40.11
(10/06/06)
52 Week High
$40.06
(9/27/06)
52 Week Low
$31.48
(10/27/05)
Profitability & Effectiveness
(ttm)
ROA
ROE
Gross Margin
Operating Margin
Net Earnings
9.75%
18.69%
51.4%
20.59%
12.72%
Market Data
Total Assets
Market Cap
Avg. Vol.
EPS (ttm)
P/E (ttm)
29.989Bil
48.76Bil
6.803Mil
$2.33
18.02
Equity Limit Prices
Stop Loss
Take Profits
$32.00
$60.00
Matthew Pufall
[email protected]
McDonald’s Corporation operates as a foodservice retailer
worldwide. It operates and franchises McDonald’s restaurants,
which offer various food items, and soft drinks and other
beverages. The company also operates Boston Market and Chipotle
Mexican Grill concept restaurants, as well as owns a minority
interest in U.K.-based Pret A Manger, a quick-service food
concept. As of July 14, 2006, it operated approximately 31,000
restaurants in 100 countries. The company has a strategic alliance
with China Petroleum & Chemical Corp. to Open Drive-Thrus in
the People’s Republic of China. McDonald’s was founded in 1948
and is based in Oak Brook, Illinois.
SUMMARY OF 2005 RESULTS2
 ª Comparable sales increased 3.9% building on a 6.9%
increase in 2004.
 ª System wide sales increased 6%. Excluding the positive
impact of currency translation, System wide sales increased
5%.
 ª Consolidated revenues increased 7% to a record high of
over $20 billion. Excluding the positive impact of currency
translation, revenues increased 6%.
 ª Net income per common share was $2.04 compared with
$1.79 in 2004.
 ª Cash from operations increased $433 million to $4.3
billion.
 ª Capital expenditures were about $1.6 billion.
 ª The annual dividend was increased 22% per share, to
$0.67 or $842 million.
 ª Share repurchases totaled about $1.2 billion.
 ª One-year ROIIC was 46.0% and three-year ROIIC was
36.6% for 2005. The decrease in Impairment and other
charges (credits) included in operating income benefited
these returns 20 percentage points and 18 percentage points,
respectively. (See other matters for details of the
calculation.)
SELECTION CRITERIA
The stock selected had to be service industry stock, large cap, a
value play, with a beta below 1.5. After looking at many sectors of
the service industry, it was apparent that there was an absence of
legitimate value plays due to the economic and market cycle.
Therefore, I look for a strong brand name with substantial
dividends, great revenue growth, and the possibility of a stock split.
After examining these criteria, McDonald’s, from the services
sector and restaurant industry, best met the criteria and constraints
imposed upon the equities to be evaluated.
Valuation:
I. P/E Multiple Valuation:
Price/Earnings Multiple
MCD Current
18.03
Industry Average1
20.52
MCD 10yr. Avg.
22.75
5
MCD 10yr. High
40
MCD 10yr. Low5
10
Multiple Valuation
$
42.01
$
47.81
$
53.01
$
93.20
$
23.30
Possible
Downside
Upside
-44.54%
121.85%
Based on the average P/E multiple for McDonald’s industry, the company is trading at a
discount. The same can be said of its historical P/E multiple. Given MCD’s ten year historical
high and low P/E’s, one can see that the upside to investing in this equity is much greater than
the downside. But the investor must be cautious because there is a significant downside should
the equity trade at a historically low P/E. If we look at the ten year average, MCD should be
trading around $50 a share. However, given the current industry average, a price above $45 is
where the stock should trade relative to industry premiums paid for earnings.
II. Damodaran Gordon Growth Model10:
Current Dividends per share =
$1.00
Cost of Equity =
8.75%
Expected Growth rate =
6.78%
54.251
Gordon Growth Model Value =
Value vs. Expected Growth
$1,000.00
$0.00
($1,000.00)
8.
78
%
7.
78
%
6.
78
%
5.
78
%
4.
78
%
3.
78
%
2.
78
%
1.
78
%
0.
78
%
Value
($3,892.38)
$111.10
$54.25
$35.66
$26.43
$20.91
$17.24
$14.63
$12.67
Value of Stock
Growth rate
8.78%
7.78%
6.78%
5.78%
4.78%
3.78%
2.78%
1.78%
0.78%
($2,000.00)
($3,000.00)
($4,000.00)
($5,000.00)
Expected Growth Rate
Current Earnings per share =
$2.33
(in currency)
Current Payout Ratio =
43.00%
(in percent)
Are you directly entering the cost of equity? (Yes or No)
If yes, enter cost of equity =
No
(in percent)
If no, enter the inputs for the CAPM
Beta of the stock =
1.06
Riskfree rate =
4.83%
(in percent)
Risk Premium=
3.70%
(in percent)
Expected Growth Rate =
6.78%
(in percent)
After running the Gordon Growth Model template offered by Professor Damodaran, and using a
6.78% growth rate (based on a forecasted increase in EPS equal to the 10 year geometric average
growth rate of dividends), a fair stock value of about $54.25 was calculated. Although MCD’s
dividend has been growing at varying levels for the past 5 years, I feel that it should stabilize
again soon around 14% due to the large adjustments MCD has been making to the dividend
payout the last 4 years. Consistent dividend growth of 40% or more seems unlikely, and I
believe the growth of the annual dividend should stabilize going forward. Therefore, the stable
GGM valuation model presented by Dr. Damodaran was the best model to use to value MCD
going forward.
III. Weighted Dividend Growth Model:
MCD Dividend Growth
Numbers Courtesy of MCD Cash Dividend History
Year
Dividend
Growth Rate
1995
$0.131
1996
$0.146
11.43%
1997
$0.161
10.26%
1998
$0.176
9.30%
1999
$0.195
10.64%
2000
$0.215
10.26%
2001
$0.225
4.65%
2002
$0.235
4.44%
2003
$0.400
70.21%
2004
$0.550
37.50%
2005
$0.670
21.82%
2006
$1.000
49.25%
Geometric Avg.
Dividend Growth Rate
10yr
5yr
14.71%
26.30%
McDonald's Inc. Valuation Calculations
Numbers Courtesy of Yahoo! Finance, MCD Annual Reports 1998-2005
Key Statistics
Beta:
Risk Free Rate:
Market Risk Premium:
1.06
4.83%
3.70%
Oustanding Forecast
(Based on best dividend growth last 10 years)
Growth Rate
Growth Rate =
70.21%
Discount Rate
Yearly Dividend Per Share
Price (Oct. 6th)
$1.00
$40.11
Discount Rate =
72.71%
Stock Valuation
Yearly Dividend Per Share
Next Year's Projected
Cummulative Dividend
Growth Rate =
Discount Rate =
$1.00
$1.70
70.21%
72.71%
Stock Price =
$68.27
Optimistic Forecast
(Based on 4yr. Geometric Average Dividend Growth Rate)
Growth Rate
Growth Rate =
41.01%
Discount Rate
Yearly Dividend Per Share
Price (Oct. 6th)
$1.00
$40.11
Discount Rate =
43.51%
Stock Valuation
Yearly Dividend Per Share
Next Year's Projected
Cummulative Dividend
Growth Rate =
Discount Rate =
Stock Price =
$1.00
$1.41
41.01%
43.51%
$56.56
Conservative Forecast
(Based on 10yr. Geometric Average Dividend Growth Rate)
Growth Rate
Growth Rate =
14.71%
Discount Rate
Yearly Dividend Per Share
Price (Oct. 6th)
$1.00
$40.11
Discount Rate =
17.20%
Stock Valuation
Yearly Dividend Per Share
Next Year's Free Cash Flow Per
Share =
Growth Rate =
Discount Rate =
$1.00
$1.15
14.71%
17.20%
Stock Price =
$46.01
Pesimistic Forecast
(Based on worst dividend growth last 10 years)
Growth Rate
Growth Rate =
4.44%
Discount Rate
Yearly Dividend Per Share
Price (Oct. 6th)
Growth Rate
$1.00
$40.11
4.44%
Discount Rate =
6.94%
Stock Valuation
Yearly Dividend Per Share
Next Year's Free Cash Flow Per
Share =
Growth Rate =
Discount Rate =
$1.04
4.44%
6.94%
Stock Price =
$41.89
$1.00
Weighted Average Valuation
Outstanding Forecast
Optimistic Forecast
Conservative Forecast
Pesimistic Forecast
Weighted Average Price
Price
$68.27
$56.56
$46.01
$41.89
Weight
2.50%
35.00%
60.00%
2.50%
$1.71
$19.80
$27.61
$1.05
100%
$50.16
CAPM Valuation
Beta:
Risk Free Rate:
Market Risk Premium:
CAPM MCD Discount Rate
CAPM Valuation
1.06
4.83%
3.70%
8.75%
$58.40
The weighted average price valuation contained on the preceding pages attempts to take
into account, and give weight, to the possible scenarios surrounding a dividend discount model
price, and the possible dividend growth rates attainable by MCD. McDonald’s began paying
dividends annually in 2000; before 2000 McDonald’s paid dividends quarterly as most firms do.
Over the last ten years, McDonald’s dividend growth rate has been anything but stable as can be
seen in the chart labeled “MCD Dividend Growth”. Therefore, the model to value this stock
must take into account the possibilities surrounding future growth rates of dividends to be paid
out.
For 2006, MCD raised their dividend by almost 50% from $.67 to $1.00. Similarly,
dividend growth rates have been consistently high over the past 4 years indicating increased
revenues and an increasing payout policy. The 10 year geometric average growth rate is still a
healthy 14%, but nowhere near the 50% seen this year. In analyzing the company, the likelihood
of another 50% dividend increase seemed possible due to strong revenue growth, a strengthened
economy, and successful product initiatives. However, this type of payout policy may prove
burdensome on retained earnings, and therefore affect future growth or extension strategies. The
most likely scenario is the conservative forecast of 10 year average geometric growth. Given the
performance of the company as of late, 14% dividend growth is a very conservative number but
values the company in a more stable light especially in the face of a possible economic
slowdown.
The outliers of 70% and 4% dividend growth rates are highly unlikely, but possible given
McDonald’s erratic growth concerning its dividend over the past 6 years. Therefore, weight was
given to these possibilities, but only a very slight amount. My valuation is more conservative
than Damodaran’s Model as well as the 10 year average P/E multiple value. I believe this is due
to the concentration on scenarios and not one specific value of growth.
Finally, the CAPM model produces a valuation of $58.40 that is primarily dependent on
the sales growth rate of MCD. I don’t feel this valuation is as accurate as the dividend discount
evaluations due to McDonald’s up and down sales growth over the last three years. 2004 saw a
growth rate of 12% while 2005 saw growth of only 6%. Therefore, if MCD sees growth
comparable to 2004, CAPM will produce a negative valuation even though the company has
produced great numbers. The discount rate and beta do not lend themselves, at least in this case,
to high growth from a stable company. (Sales discount rate used in the CAPM model was the
same as the sales growth number used in the Damodaran Model).
Economic & Industry Conditions (Competitors):
With regard to economic conditions, McDonald’s is consistently at risk regarding
commodity prices, exchange rates, and political turmoil due to its global nature and scale.
Therefore, it must carefully hedge for changes in exchange rates and commodity prices due to its
major function as a supplier to franchise units all over the world.
According to Yahoo! Finance, McDonald’s main competitors are Burger King, Wendy’s,
and Yum Brands. As can be seen in the accompanying tables, McDonald’s is far and away
superior to its competitors in almost all of the comparison categories. Over concern though may
be the numbers tied to the PEG ratio and Price/Sales ratio. Both are higher than competitors and
the industry suggesting that MCD is trading at a premium, and might possibly be overvalued.
Contrary to that belief, the premium that shareholders are paying to own McDonald’s is in large
part due to the company’s strong brand, consistent earnings, and substantial dividend that rose
almost 50% this year. The competition in the restaurant services industry is extremely
competitive though. For example, Yum! Brands is comprised of “KFC, Pizza Hut, Taco Bell,
Long John Silver, and A&W All-American Food Restaurants that offer Mexican-style food
categories”1. Wendy’s is also another strong brand that just completed a spin-off of Tim
Horton’s, a quick service restaurant operating mainly out of Canada and offers products and
services comparable to Starbucks or Dunkin Doughnuts. Burger King has been floundering
relative to the rest of its industry, and is trading at an unbelievable P/E ratio of about 72.
Unfortunately for McDonald’s, competitors go far beyond just other fast food restaurants such as
those detailed below. Starbucks could be seen as a major competitor due to its wide variety of
offerings which include hot breakfast sandwiches (at this time they are being served in New
York). Any meal substitute or value diner is a potential competitor of McDonald’s.
Competition becomes fiercer everyday with the addition of new offerings, cheaper prices,
and new locations created by all restaurant industry members. Going forward into 2007 the
major battle to be won according to analysts and reports is going to be for consumers’ breakfast
dollars. Wendy’s is rolling out a breakfast menu in 2007, Starbucks, as mentioned above, is
testing warm breakfast sandwiches, and burger king already has a substantial breakfast offering.
McDonald’s has even been considering offering breakfast all day long in the near future. The
ability to have HotCakes, or an Egg McMuffin with cheese, anytime may be necessary to win the
battle for consumers’ breakfast bucks.

Burger King

Wendy’s

Yum! Brands
Statistic
Industry Leader
MCD
MCD
Rank
MCD Market Capitalization
P/E Ratio (ttm)
MCD
49.05B
BKC
70.13
PEG Ratio (ttm, 5 yr expected) DENN
5.63
Revenue Growth (Qtrly YoY) TRY
EPS Growth (Qtrly YoY)
1.98
7 / 68
2852.30% 60.00% 12 / 68
MRT
31.0%
8.5% 37 / 68
14573.69% 18.69% 14 / 68
BOBS.OB
Long-Term Debt/Equity (mrq) MRFD.OB
Dividend Yield (annual)
18.03 35 / 68
228.40% 9.40% 24 / 68
Long-Term Growth Rate (5 yr) BJRI
Return on Equity (ttm)
1 / 68 vs.
-
20059.000
STRZ
0.608 17 / 68
4 / 68
7.60% 2.50%
Industry Leaders
DIRECT COMPETITOR COMPARISON
MCD
BKC
WEN
YUM
Industry
Market Cap:
48.81B
2.25B
4.01B
14.69B
328.11M
Employees:
447,000
37,000
10,000
59,840
3.17K
9.40%
6.00%
8.30%
1.30%
7.00%
Revenue (ttm):
21.23B
2.05B
3.90B
9.41B
311.48M
Gross Margin (ttm):
31.22%
33.94%
23.71%
47.72%
33.52%
5.67B
268.00M
604.03M
1.74B
37.03M
20.59%
8.79%
9.71%
12.99%
6.08%
Net Income (ttm):
2.80B
27.00M
124.17M
793.00M
5.90M
EPS (ttm):
2.218
0.235
1.056
2.749
0.55
P/E (ttm):
17.94
71.87
32.24
19.73
20.99
PEG (5 yr expected):
1.99
0.98
1.24
1.58
1.45
P/S (ttm):
2.31
1.07
1.03
1.57
0.83
Qtrly Rev Growth (yoy):
EBITDA (ttm):
Oper Margins (ttm):
Tables courtesy of Yahoo! Finance
Chipotle Spin-Off:
OAK BROOK Ill. (AP)6 – “Fast food retailer McDonald's Corp. said Thursday the final
exchange ratio for McDonald's shares to Mexican fast-food chain Chipotle Mexican Grill Inc.
shares is 0.8879. The exchange offer, which expires at midnight eastern time Thursday, allows
McDonald's to spin off its interest in Denver-based Chipotle, and lets McDonald's shareholders
exchange stock for shares of Chipotle. The company said the final per-share value of
McDonald's common stock to Chipotle class B common stock in the exchange is $39.91845 and
$49.95375, respectively. Last month McDonald's announced plans to spin off its remaining 51
percent stake in Chipotle, which went public in January.” This offer expired on October 5, 2006.
The stock price may fluctuate for a time after this option expires due to less desirability
surrounding the stock and the lost of convertibility into shares of Chipotle Mexican restaurant.
The spin-off will allow McDonald’s to focus on its core competencies, Plan to Win, and other
brand strengthening efforts.
Analysts’ Estimates:
Based on the information provided by Yahoo! Finance, many analysts are bullish about
McDonald’s prospects with 16 analysts recommending a buy or strong buy. Unlike the price
projections offered earlier in this report, analysts are less inclined to value McDonald’s stock in
excess of $50.00. Differing from the view of the majority of analysts, Standard and Poor’s
believes that McDonald’s is an equity to be held right now and not acquired. They have a target
price of $44.00 for the next year.
Furthermore, through their analysis, they believe that McDonald’s is overvalued currently, but is
an investment that is more attractive than almost all of the other stocks Standard and Poor’s
follows.
RECOMMENDATION TRENDS7
Current Month
Last Month
Two Months Ago
Three Months
Ago
Strong Buy
9
8
8
8
Buy
7
7
9
8
Hold
3
2
2
3
Sell
0
0
0
0
Strong Sell
0
0
0
0
PRICE TARGET SUMMARY7
Mean Target:
Median Target:
High Target:
Low Target:
No. of Brokers:
42.83
43
46
38
12
RECOMMENDATION SUMMARY7*
Mean Recommendation (this
week):
1.8
Mean Recommendation (last
1.7
Change:
0.1
Insider Transactions
When looking at Vicker’s insider trading chronology for the past year, one can see that it
has been mixed with regard to purchases and sales. Standard and Poor’s sees the action as
neutral, but I believe some transactions are concerning due to the fact that some insiders have
sold substantial positions in the company; some have even liquidated 100% of their holdings.
They are curious transactions especially when taking into account the huge dividend increase
McDonald’s just posted for Fiscal 2006. What issues are insiders seeing that they are willing to
forgo a $1.00 dividend per share?
Conclusion:
Pros
Cons
Hefty dividend increases over the past 5 years
Strongest brand name in industry
Outperforming all competitors
Strong Growth Rates
Increased competition
High P/S and PEG values
Insider activity
Tough entry point for a value play
Many strong buy recommendations
Global presence
Global presence
Consumer lifestyle shifts (healthy fare)
Overall, McDonald’s represents a strong large cap firm with an outstanding record of
consistent and growing dividends. There is added risk with regard to gains due to MCD’s price
relative to its 52 week high as well as erratic sales and dividend growth rates over the past few
years. However, MCD has split at prices ranging between $55 and $90 over the past 35 years
indicating that the stock may still have a lot of room for appreciation as well as the possibility of
an increased stake in the company should it split again around $55. It must be pointed out,
however, that the stock has traded at levels as low as $12 per share as recently as 3 years ago.
Given the outstanding level of growth MCD has enjoyed over the past 4 years, I believe it is a
solid, and growing, large cap stock. Given its reasonable beta (1.06) and great dividend yield, I
feel that MCD is a moderate buy and would be a great addition to the Mizzou Investment Fund.
Works Cited:
1. Yahoo! Finance http://finance.yahoo.com/q?s=pg.
2. McDonald’s 2005 Annual Report. http://www.mcdonalds.com/corp/invest/pub.html.
3. Damodaran Online. http://pages.stern.nyu.edu/~adamodar/
4. TDAmeritrade https://webbroker.tdwaterhouse.com/scripts/webBroker.dll.
5. Standard and Poor’s Stock Report. McDonald’s. 9 Sept. 2006.
2006 Standard & Poor's, a division of The McGraw-Hill Companies, Inc.
6. Vicker’s Insider Trading Chronology. McDonald’s.
7. Associated Press. “McDonald’s Sets Chipotle Exchange”. 5 Oct. 2006.
http://biz.yahoo.com/ap/061005/mcdonald_s_chipotle_spinoff.html?.v=1
8. Data provided by Thomson/First Call