Saturday, August 25, 2012

McDonald's - A Wonderful Company

Living as frugally as I do, honestly I don't visit McDonald's very often. I decided early this morning I was going to write about McD's and decided to visit a McDonald's location close to my work today for lunch (for research and yummy goodness). I ordered a #1, which for anyone living under a rock is a Big Mac meal. This brand has such recognition and exposure, I bet there are very few people that don't already know that fact. Just one reason it's such a great company. I sat down to eat my lunch next to a father and his young son. The child was eating a Happy Meal and he was actually proclaiming to his father "This is my favorite restaurant in the whole world!". That kind of stuff gets me pretty excited about a business. I know some people blather on about separating emotion from investing, but I like the old story about Peter Lynch shopping with his wife and discovering a pantyhose brand to invest in after his wife proclaimed how great the product was. A great product is usually produced by a wonderful company.

A little about the company, per Morningstar:

McDonald's generates revenue through company-owned restaurants, franchise royalties, and licensing pacts. Restaurants offer a uniform value-priced menu, with some regional variations. As of December 2010, there were 32,700 locations in 117 countries, including 26,300 operated by franchisees/affiliates and 6,400 company units. 

Of course, that tells us little about McDonald's. This is a global icon. It has a large moat around it's business and it's revenues absolutely crush any comparable food chain. It's brand and logo can be recognized by almost anyone, anywhere. I think they have a wonderful brand, a great image and a solid product lineup.

McDonald's financial positions are very strong. Let's take a look.

Earnings per share have more than doubled since 2005. EPS has grown by an annual clip of 20.75%.

Earnings Per Share ($)
1Q 2Q 3Q 4Q Year
2010 1.00 1.13 1.29 1.16 4.58
2009 0.87 0.98 1.15 1.11 4.11
2008 0.81 1.04 1.05 0.87 3.76
2007 0.63 -0.59 0.83 1.06 1.93
2006 0.46 0.56 0.67 0.61 2.30
2005 0.56 0.42 0.58 0.48 2.04

Revenue growth is also impressive. Revenue has grown by 2.94% per year. 

Revenue (Million $)
1Q 2Q 3Q 4Q Year
2010 5,610 5,946 6,305 6,214 24,075
2009 5,077 5,647 6,047 5,973 22,745
2008 5,615 6,075 6,267 5,565 23,522
2007 5,293 5,839 5,901 5,754 22,787
2006 4,914 5,367 5,671 5,634 21,586
2005 4,803 5,096 5,327 5,235 20,460

Dividend growth is also very wonderful with this company. Obviously this is the juicy part of the investment and this is what we, the shareholders, get in return for our faithful investment into the company. It's money returned to use for reinvestment or other capital allocation as we see fit.

Dividend growth has averaged 39% over the last 6 years, but slowed from 2009-2010 with a 10.2% increase. 

Dividend Per Year ($ Per Share)
2010 2.26
2009 2.05
2008 1.62
2007 1.50
2006 1.00
2005  .67

Excellent, excellent, excellent growth in this area. However, it should be noted that the payout ratio has also increased during this amazing run. I expect slower, but generous increases going forward. Commodities across the board are increasing and even McDonald's is not immune to an increase in input and foot costs. They are however, one of the biggest players in the world and do have immense pricing power and economies of scale from which to spread out the impact. The consumer will eventually see some of these costs passed on.

Overall, I love McDonald's. I think they are second to none when it comes to the fast food arena. I love the makeovers and the "upscale" lounges they now employ in a number of restaurants worldwide. The coffee and smoothie section as part of the McCafe brand has caught on well. They are expanding on healthy choices. They are expanding the footprint in emerging markets. I see a lot of growth still ahead for McDonald's. 

The company does have risks. The company does not have the healthiest portfolio of food offerings. There is some backlash over that, including a suit in California over the inclusion of toys in Happy Meals. The economy is still fragile and commodities are starting to increase across the board. Higher input costs mean higher prices for the consumer, which could lead to people going elsewhere. I really don't believe this will happen, as my opinion is that McDonald's offers some of the best tasting and highest quality fast food around. I think only Wendy's offers food of comparable quality, but their lounges are often not as upscale and the food is usually much higher in price.

My opinion is that this is a wonderful businesses. It is trading at an attractive 16.74 P/E ratio with an entry yield of 3.18%. I think anything below $82.44 is an attractive price point. Although it is not the best value on the market right now I do think it's a wonderful business with an attractive entry yield, a substantial dividend growth history and a wonderful lineup of products. It has one of the world's most recognizable brands and has an extremely large moat around it.

I am long MCD.

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  1. One thing about McDonald's is that they are a massive franchiser. Currently about a third of their revenue isn't from direct sales in their stores, but franchise and licensing fees paid to them. In looking at their most recent 10-K I noticed that actual sales at company-operated stores increased by 18.7% from 2006 to 2011, but franchise fees increased by 58.6%.

    Their net income from 2006 to 2011 increased by 55.2% and I believe that most of that increase is coming from the franchise fees. Those fees won't be affected by changes in commodity prices, so it gives the company a nice buffer in their net profit margin.

    1. Robert,

      Thanks for adding that. This article was written a while ago and got re-published on The Div-Net, but the qualitative nature of the post still stands.

      Excellent information there about one of the major strengths of MCD's core business being a franchiser and the rewards that comes with. That does shield MCD from some of the issues with rising commodity costs, which would impact franchisees.

      Best wishes!


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