Premier Thoughts: The CSUB Business Blog Iryna Putilina Economic Research Center putiryna@gmail.com www.csub.edu/kej CSUB Accounting and Finance Major December 13, 2010 A Financial Analysis of McDonald s Corporation The McDonald s Corporation is a well-developed multinational company that conducts business in 117 countries. The company and its franchisees have operated in the highly demanding and competitive fast food industry since May 15, 1940. As stated in the company s mission statement, McDonald s competes on the basis of price, convenience, service, menu variety and product quality in a highly fragmented global restaurant industry. 1 The company faces many risks, such as foreign exchange rates, interest rates, inflation, and industry regulations. In addition, current economic conditions described as slowing economies, rising unemployment, declining wages, constrained credit, and volatile financial markets make it even harder to compete in the marketplace. 2 Based on the company s strategy, comparable sales and comparable guest-counts are key performance indicators used throughout the retail industry and are indicative of acceptance of the company s initiatives as well as local economic and consumer trends. 3 The McDonald s Corporation has gained competitive advantage in both national and international fast food industry. McDonald s net income climbed from $2.4 billion in 2007 to $4.3 billion in 2008, and $4.5 billion in 2009; it is projected to reach $4.6 billion in 2010 and $5.0 billion in 2011. 4 However, McDonald s stocks are traded less than its mean and median target value. The following target summary shows predictions for McDonald s stock prices. The low target for stock of McDonald s is $73.00, while the mean target is $85.56. The close price at which McDonald s stock was traded on December 10, 2010 was $77.56 with a decrease of 0.5 percent. Price Target Summary Mean Target $85.56 Median Target $86.00 High Target $92.00 Low Target $73.00 Mean Target $85.56 Median Target $86.00 1 McDonald s, Corporation, 10-K Annual Report 2009; retrieved October 11, 2010 from Bloomberg Business Week database, 2010 2 Ibid. 3 Ibid. 4 www.msn.com, Money, Investing 1
My examination of McDonald s financial statements and calculation of its basic ratios are useful tools in determining current conditions of the company. As a benchmark for this analysis, five top competitors and five bottom competitors based on their collected revenues are selected. McDonald s top five top competitors are Yum Brands Inc., Wendy s/arby s Group Inc., Jack in the Box Inc., Cracker Barrel Old Country Store Inc., and Dominos Pizza Inc. Its bottom five competitors in the industry are Brazil Fast Food Corporation, Morgan s Foods Inc., Rick s Cabaret International Inc., Nathan s Famous Inc., and Good Times Restaurants Inc. The following chart depicts the trend in McDonald s stock prices relative to its main rival, Yum Brands Inc. from November 1, 2009 to November 1, 2010. Yum Brands operates five worldwide franchises: Kentucky Fried Chicken (KFC), Pizza Hut, Taco Bell, Long John Silver s, and All American Food Restaurants (A&W). Over this period, McDonald s price climbed 22.3 percent or $14.01 per share from $62.72 to $76.73. Likewise, Yum Brand s price soared 36.9 percent or $13.11 per share from $35.49 to $48.60. Although McDonald s had a greater dollar gain, Yum Brand outperformed McDonald s with a faster growth rate. 5 Exhibit 1 shows McDonald s standing compared to the other companies in the fast food industry with respect to the profitability ratios. These ratios are important for investors to evaluate and decide if the company is healthy for investment and what returns to expect on their investment. Accordingly, McDonald s holds a strong position among its competitors. McDonald s return on investment (ROI) of 20.6 percent is less than the industry average of 29.9 percent and that of its top five competitors of 30.2 percent. Similarly, McDonald s return on equity (ROE) of 23.9 percent is below the industry average of 28.2 percent and that of its top five competitors 45.0 percent. These ratios might reduce McDonald s market value because ROI and ROE are two major ratios investors analyze when they consider capital investment. 5 Ibid. 2
Exhibit 2 presents the industry s liquidity ratios. Likewise, these ratios help determine McDonald s standing among its competitors. The liquidity ratios are important to debtors to see the strength of credit rating of a particular company. McDonald s ratio of 28.3 percent is close to the industry average of that of its competitors. The fluctuations among the ratios are insignificant for detailed analysis. 3
Exhibit 3 shows the industry s debt ratios, which are the measurements of the company s ability to pay its debts on time. McDonald s position against its competitors is weak. Although McDonald s 10-K report mentions that the company has no problem in the credit market, low ratios might discourage investors to buy stock. McDonald s quick ratio of 0.6 is considerably less than the industry average of 3.4 and its top five competitors of 2.3. Similarly, McDonald s longterm debt to equity ratio of 0.6 is less than the industry average of 4.4 or its competitors of 2.4. These ratios might frighten investors knowing that debtors would be the first in life to receive compensation during bankruptcy or other hard conditions to the company. Exhibit 4 shows the industry s asset management ratios. These ratios are important indicators of the company s management strategies and internal decision-making. McDonald s asset turnover ratio of 0.8 percent is less than the industry average of 13.0 and that of its competitors of 1.8. Similarly, the ratio of cash and cash equivalents of 9.7 is much smaller than the industry average of 32.2. Despite these low ratios, McDonald s has a notable advantage in the inventory turnover of 102.0 compared to the industry average of 45.9. 6 6 Data used for Exhibits 1-4 are collected from Yahoo.com finance Analyst Option provided by Thomson/First Call, they were first retrieved October 10, 2010 4
Since the current economic environment has increased consumer focus on value, heightening pricing pressures across the industry, which could affect ability to continue to grow sales despite the strength of brand and value proposition and simple analysis of ratios, McDonald s should change its means to achieve strategies. 7 In addition, since major part of the company s strategy is being better, not just bigger, McDonald s should devote more equity and value to not only developing new markets, but also strengthening its position in the current markets. 8 The issue that McDonald s is facing relates to its ability to increase market share without losing sales and operating income over both short- and long-term. Thus, McDonald s should pay more attention to the existing restaurants rather than opening new ones. Similarly, McDonald s must place greater emphasis on sales rather profits and prices of its products. In addition, McDonald s strives for evolution toward a more heavily franchised, less capitalintensive business model has favorable implications for the strength and stability of its cash flow, the amount of capital it invest and long-term returns. 9 This poses a problem in the current condition and market. Since many of McDonald s restaurants are situated in the United States, where the housing market is still in recession, I suggest to McDonald s to reduce the amount of leases and increase the amount of the capital property it has right now. Since the cost of the building has decreased, this is a good time for the company to acquire new property. In addition, cash and cash equivalents are important for the labor cost increases similar to the revenue. As stated, labor costs given labor-intensive business model, long-term 7 McDonald s, Corporation, 10-K Annual Report 2009; retrieved October 11, 2010 from Bloomberg Business Week database, 2010 8 Ibid. 9 Ibid. 5
trend toward higher wages [and] potential impact of union organizing efforts should be accounted for in the short- and long-run. 10 Here, I suggest a three-year strategic plan for improving McDonald s financial condition, leading to increased market value. Looking at the cash available, McDonald s is not covered enough currently. Media reports can affect the outcome and trading price of the stock even if the media reports are not directly related to the company. In addition, stock prices can be affected by dividend rate or changes in our debt levels on our credit ratings, interest expense, ability to obtain funding on favorable terms or our operating or financial covenants. 11 Thus, McDonald s should devote great attention to the level of debt, media promotion, and dividends. Strategic Timetable 1 year Increase cash balance and cash on hands Pay-off some of the debt to increase trust of investors Increase acquisition of buildings Decrease dividends Invest short term the cash that was gathered from sold investments 2 years Increase cash balance and invest cash on hand into short term investments Pay-off more debt Increase the investment portfolio (2009 sold many investments profitably) 3 years Continue improving current condition and balance between debt and equity mix Since McDonald s mentions that its decreased revenues are offset by lower capital expenditures, primarily in the U.S., it should acquire more building capital in the near future. 12 Next year, management should evaluate cites of the significant revenue generation and acquire buildings for few of those cites in United States. On the other hand, since property in European countries, where about 35 percent of business is situated, McDonald s should increase the amount of leases to decrease the capital expenditures. As stated by the company, increase in cash in financing activities primarily due to lower net debt issuances, an increase in the common stock dividend and lower proceeds from stock option exercises, partly offset by lower treasure stock purchases, McDonald s should concentrate more on the financing activities. 13 Since debt is cheaper way to acquire capital, McDonald s is using great amount of debt. Even though McDonald s mentions the availability of the debt and credit in the market, the problems might arise later and decrease in debt leverage might increase the value of the stock for the company. Similarly, since McDonald s uses favors short-term debt, it should definitely increase its amount of cash and cash equivalents, which have declined last year - a decrease of $267 million in 10 Ibid. 11 Ibid. 12 Ibid. 13 Ibid. 6
2009 compared with an increase of $82 million in 2008. 14 Since McDonald s shows weak ratios in some areas, increase in dividends seems to be a sign of persuasion for the investors. Since dividends paid in 2009 amounted to $2.05 per share an increase from $1.625 in 2008, and $1.5 in 2007 with decreased cash flow for the company, questionable management strategy arises. Future decreases in the dividends might be needed, perhaps in the next year. If the dividends are to decline, the company might have more cash to finance its short-term investments and debt. In addition, the company should increase its cash on hand in the near future, perhaps in the upcoming year and decrease debt amount through more collateral such as purchase of new cites. 14 Ibid. 7