HOLD. Ticker: MCD Sector: Consumer Services Industry: Restaurants and Bars. Recommendation:

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1 Ticker: MCD Sector: Consumer Services Industry: Restaurants and Bars Recommendation: HOLD Data: Price 52-wk high 52-wk low $54.23 (14-Sept-09) $65.47 (19-Sept-08) $45.79 (10-Oct-08) Market cap $59.18B Total assets $ B Trading Vol 9.08M EPS (Q2 2009) $1.85 EPS (2008) $3.84 EPS (2007) $3.70 EPS (2006) $3.55 P/E (ttm) Div Yield 2.0% ROA (ttm) 13.05% ROE (ttm) 30.50% Report by Jake Schanzmeyer 14-Sept-09 McDonalds Corporations is one of the largest and most globally recognizable brands and serves nearly 47 million customers daily. MCD operates in more than 118 countries and as of yearend 2008 had over 31,000 locations worldwide. McDonalds operates the majority of the restaurants through franchising agreements and in 2008 only 6,502 were ran by the corporation. MCD is headquarter in Oak Brook, IL and employs over 400,000 people worldwide. McDonalds was founded in 1948 by Dick and Mac McDonald. The first McDonalds franchise was purchased in 1955 by Ray Kroc who later purchased the McDonald brothers equity in the company and led its worldwide expansion. MCD Corporations revenues come from rent, royalties, and fees paid by McDonald s franchises as well as sales from the company operated restaurants. MCD has two types of franchise arrangements. In the conventional franchise arrangement, franchisees provide a portion of the required capital and MCD owns the land and building or secures long term leases for sites. Under the developmental license arrangement, licensees provide capital for the entire business, including the real estate, while MCD generally has no capital invested. MCD Corporation has seen significant changes in recent history and has seen substantial long term growth. Some of the most recent changes have been to promote new products and meals for the health conscious consumer. Some of the new menu items include salads, fruits, and wraps. McDonalds continues to invest in its growth and development by continually enhancing the quality of the service, food, and restaurants. One of the most recent initiatives for MCD is the push to compete in the premium coffee business with companies such as Starbucks and Dunkin Donuts.

2 Financials Quarter end 30-June-09 Last month MCD released it second quarter financial statement for 2009 with some good signs for the corporation. As economy continues to be hit hard and consumers continue to decrease spending MCD continues to push the Plan to Win strategy. The company posted higher revenues, operating income, and earnings per share compared with the prior year. Some of the key aspects of the report issued by MCD are: Figure 1 McDonald's reported the following second quarter highlights: -- Global comparable sales increased 4.8% with the U.S. up 3.5%, Europe up 6.9% and Asia/Pacific, Middle East and Africa up 4.4% -- Consolidated operating income increased 2% (11% in constant currencies) -- Earnings per share were $0.98, including $0.09 per share of negative impact from foreign currency translation and $0.01 per share of incremental income related primarily to the sale of Redbox Automated Retail, LLC and also related to the developmental license transaction in Indonesia. Second quarter 2008 earnings of $1.04 per share included a $0.10 per share gain from the Company's sale of its minority interest in Pret A Manger -- Approximately $1.4 billion returned to shareholders through share repurchases and dividends -- On July 22, McDonald's Board of Directors declared a quarterly cash dividend of $0.50 per share of common stock, payable on September 15, 2009 to shareholders of record at the close of business on September 1, 2009 Source: McDonald s Corporation As consumers continue to be more cost conscious, the value, quality, and convenience McDonald s continues to offer is a driving force behind its continued success and growth. The highlights from the second quarter reports give a sign of life for MCD despite bleak first quarter 2009 financials. As consumer spending increases there are good signs that MCD will continue to see increases in revenues, operating income, and earnings per share. For July and August MCD continues to see increases in sales of 4.3 and 2.2% respectively. The most significant increases continue to be in Europe. Another bright spot of the quarterly report is the cash dividend of $.50 per share of common stock. The business operations of MCD are primarily distinguished by four geographic segments: US, Europe (EU), Asia Pacific Middle East and Africa (APMEA), and Other Countries and Corporate. The US accounted for 28.9% of company operated sales and 52.6% of franchise revenues and 36.2% of total revenues for the quarter ending 30-June EU, APMEA, and other countries accounted for 40.1, 18.6, and 5.1% respectively. The report shows MCD s continued increase in

3 revenue in Europe and the continued importance of the European market on the future success of MCD. Figure 2 With the strong brand name and dominate presence globally analyst continue to predict significant growth for MCD in the future. Despite poor predictions for the restaurant industry sector, MCD is still predicted to grow by 4.8% this quarter and 6% for the year. Analyst also predict EPS for the year at $3.89 which is up from last year. Figure 3 Source: Yahoo Finance

4 Competition MCD major competitors include Burger King and Yum Brands, the holding company for fast food chains Pizza Hut, KFC, and Taco Bell. As a whole fast food chains have remained less effected by the down economy in relation to the restaurant industry and full service restaurants. With the increase push for healthier alternatives, competitions among fast food restaurants to adapt and change their menus, continues to be at the forefront of discussions. Yum Brands continues to be MCD s biggest competition and the comparison below shows that they have consistently outperformed MCD over the past 6 months. Figure 4 Source: Google Finance In comparison to the industry as a whole, MCD continues to show bright signs and continuing improvement off its 52 week low last October. The size of MCD in relation to the industry allows it to remain stable and absorb market fluctuations and changes much easier than its much smaller competitors. MCD also compares very well with its competitors when you look at both debt to equity and debt to asset as well. Figure 5 Source: Google Finance

5 SWOT Analysis Strengths The biggest strength of McDonald s is its brand name. McDonalds is a brand that is recognized by men, women, and children all over the world and continues to be the staple for service and value in the fast food industry. In 2008 McDonald s was ranked 8 th in the business week top 100 global brands and valued the brand name at over $31 Billion. Another major strength of McDonald s is its huge economies of scale. With revenues of nearly 10 times that of its competitors Wendy s and Burger King, McDonalds has a significant advantage entering new markets and selecting restaurant locations. McDonalds can be found almost anywhere, including neighborhoods, shopping malls, airports, and Wal-Marts. These huge economies of scale also give MCD significant advantages with supplier negotiations and pricing. Another major strength of MCD is their diversified geographic presence. This allows them to reduce risks and capitalize on different markets in order to maintain stable revenue growth. Weaknesses One of the major weaknesses of MCD is its continued increase in litigation around the world. MCD continues to be part in many lawsuits such as violation of state consumer fraud acts, unfair competition or deceptive trade, practices acts, strict liability, failure to warn, negligence, breach of express and implied warranties, fraud and fraudulent concealment, negligent misrepresentation and concealment, unjust enrichment, and false advertisement. Litigation continues to be a significant unnecessary cost for MCD. Opportunities The growth of franchisee operated restaurants is one of the major opportunities for MCD both in the US and globally. MCD has seen increase income from franchises over the past years and wants to continue that growth into the future. There have been many changes in order to maximize long term brand performance and returns. In 2007 MCD completed the transition of over 1500 franchises in Latin America to 20 year master franchise agreements. The continuing push to transition company operated restaurants to franchisees and development licenses is likes to increase the overall profitability of McDonalds. The growth of the hot beverage market also looks to be a promising opportunity for MCD in the near future. The hot drinks market in predicted to increase by nearly 13.1% over the next 3 years with coffee accounting for 54.7% of the total market. In order to take advantage of this increase MCD has began rolling out espresso based hot and cold specialty coffee drinks. This new venture is expected to grow MCD s presence in the beverage industry and offer great opportunities for expanding its revenue base.

6 Threats The major threat to MCD is the affect of the economic downturn on consumer spending. As personal finances continue to be hit and consumers continue to be more cautious of unnessary spending. All major western regions, including the US and UK are in a recession and are forecasted to remain so through Even key emerging markets economies such as China are experiencing downturns which have affected MCD. MCD is highly dependent on customer traffic and with decrease in consumer spending could put some short term pressure on the company s margins. Valuation For the valuation of McDonald s Corporation I will be using the Warren Buffet Owner Earnings Model. Using this model I will look at three important factors to determine the overall intrinsic value of MCD. The model will also allow for the valuation to be compared to different values related to growth rates, market returns, and Discount rates. Discount Rate In order to calculate a discount rate we must look at the risk free rate, beta, and the equity market risk premium. Using an average beta of.66 and risk free rate of.127% and a market return of 12% we can calculate a discount rate of: With the current state of the economy and the normal market return of 10-11%, I have decided to add 5% to the discount rate. Growth Rates I used growth rates from averages of Google Finance, and Yahoo we estimated growth of 6% for 2009, 9.8% for 2010, and 9% five years following. I also used a 3% second stage growth rate. The estimate reflect conservative assumptions and averages in order to not overvalue the long term growth. With a company as strong as McDonalds we would expect to see steady long term success.

7 Intrinsic Value and Recommendations Using the DCF, or Warren Buffet Way Owners Earning Discount Model, I was able to calculate that McDonald s has an intrinsic value of $ This is very close to the current price and shows that it is valued fairly. Also investors such as JP Morgan and Citi have MCD listed as a steady performer and a hold or buy in their recommendations. I believe moving forward MCD will continue to be a steady performer and maintain a strong position despite an uncertain economy because of its large size relative to the industry. MCD also has a diversified geographic presence which will also allow it to accommodate uncertain and changing economies. Figure 6

8 References: Charts News and Statistical Numbers Financial Statements SWOT Analysis - Business Source Premier Charts News and Statistical Numbers