Mcdonald\'s Financial Analysis the Beta

McDonald's Financial Analysis

The beta for McDonald's is 0.63.

The current price of McDonald's stock is $68.01 per share as of market close on May 7th, 2010. The price as of May 11th, 2009 was $53.46. Over this time period, McDonald's paid dividends of $2.05. This included three quarterly dividends of $0.50 in 2009 and a first quarter dividend of $0.55 in 2010. The total holding period return of McDonalds for the past year therefore is as follows:

The S&P 500 is presently at 1110.88. The S&P 500 as of May 11th, 2009 was 909.24. This gives the total value return on the S&P 500 for the past year as follows:

McDonalds' most recent ROE was 34.8%. The five-year average ROE is 22.7%.

There are a couple of ways to view the required rate of return. One way to estimate this is to take the ROI, or 5-year average ROI. The current ROI for McDonald's is 17.6% and the five-year average ROI is 13.0%. Another way to view the required is the weighted average cost of capital. This would involve calculating the cost of debt at McDonald's. The company's most recent bond issue, which had a seven-year term, had an interest rate of 4.25%. These bonds, rated 'A' by Fitch, should yield around 3.75% in the market today, given where other 'A' rated nine-year corporates trade.

The cost of equity can be calculated using the capital asset pricing model, with the assumption of a market risk premium of 7%. The current risk free rate, based on the rate on one year treasuries is 0.437%

Rf + B (Rm-Rf) = 0.437 + 0.63 (7) = 4.847%

McDonalds' capital structure is 52.67% debt and 47.33% equity. Therefore the weighted average cost of capital would be as follows:

(.5267)(3.75) + (.4733)(4.847) = 4.269%

This indicates that the required rate of return is around 4.269% plus a premium to reflect opportunity cost. Most of McDonald's activities, given a return on investment of 13%, earn comfortably more than the required rate of return.

6. Sales for 2009 were $22.744 billion. The five-year average sales growth rate is 4.11%. The geometric mean cannot be calculated because McDonald's saw negative revenue growth last year.

7. The normalized EPS for 2009 was $4.09. The diluted EPS for 2009 was $4.04. The EPS has trended steadily upwards for the past five years. In 2005 for example the EPS was $2.12. In 2006 it was $2.48; in 2007 it was $2.94; in 2008 it was $3.80.

8. The most recent net margin for McDonald's was 20.0%, based on a net profit of $4.551 billion and revenue of $22.744 billion. The net margin has fluctuated over the past five years. In 2005 it was 13.6%; in 2006 it was 13.7%; in 2007 it was 10.2% indicated a trend towards decline. This reversed in 2008 however with a net margin of 18.3%, kickstarting the current upward trend in net margin.

9. McDonald's pays an annual dividend. The dividend is now $2.20 per share. Last year it was $1.63 per share. Five years ago the annual dividends were $0.67 per share.

10. The company's main competitor is Yum Brands, owner of Pizza Hut, Taco Bell, KFC and most a&W locations. Yum is the main competitor of McDonald's not only because of its strong domestic position but because it is equally well positioned in key overseas markets. These markets -- China, India, Russia, Brazil etc. -- are the key drivers of growth in the industry and Yum has positioned KFC and Pizza Hut very well in these markets. Other burger chains like Burger King and Wendy's do not match McDonald's overseas presence; Yum does.

11. The major risk to this industry is social trends. For the most part, the fast food business is resistant to economic downturn. Social trends, however, can turn people away from fast food and onto better eating, sit-down restaurants (as in the boom of casual dining in the 1990s) or towards menu options not conducive to the fast food format.

12. The most significant opportunity for the industry is overseas growth. The domestic market is mature but many overseas countries would take years to saturate to the level at which North America is saturated. China and India alone have over one billion middle members of the middle class, a market as big as the entire developed world put together. These markets -- along with South America -- are the key growth markets for the industry going forward.

13. I could cite support for any view, but this question is unclear. My views "in 1 and 2" makes no sense because questions 1 and 2 do not deal with my views on anything. They are computations.

14. The industry outlook is difficult in the developed world. The market is mature and competition is intense. Most firms compete on price and on brand. Growth is limited and profit margins are being squeezed. Social trends are pushing fast food companies away from their traditional salty, fatty foods as well. In overseas markets, however, growth rates are strong. There are many untapped markets around the world that the industry will continue to exploit over the course of the next 10-20 years. Firms will build out capacity in an attempt to saturated developed markets.

15. The most recent ROE for Yum Brands is 180.7%. This figure reflects the high level of debt at Yum, which has a debt ratio of 85.6%. The company has taken on a significant amount of long-term debt in order to build out capacity in overseas markets. Yum is using debt as part of an aggressive growth strategy -- far more aggressive than that at McDonalds.

Part 2. The main strengths at McDonalds are its brand equity, its purchasing and logistics systems, its market saturation and its relatively healthy balance sheet. The company's brand is one of the most widely recognized in the world. While a portion of the market views the brand negatively, most consumers have positive impressions of McDonalds. The brand's high esteem and instant recognizeability means that the company can easily move into overseas markets. McDonald's backs up its cost leadership strategy with logistics and purchasing, both of which are done on such great economies of scale that the company's cost structure is lower than that of many competitors.

McDonald's has few weaknesses. For a small portion of the market, the poor quality of the food is a turnoff, but most of the market enjoys the food. The brand equity has been able to withstand the company being targeted for alleged environmental abuses. The decline in sales last year is more closely related to difficulties in the external environment than any internal weakness. If McDonald's has a weakness -- and that is a big "if" given the company's track record -- it has failed to develop viable new menu options. Most of its initiatives in new product development fail. The company is, for better or worse, married to its burgers and fries. While this reduces flexibility in the domestic market, McDonalds has been able to adapt its menu overseas successfully.

The biggest opportunity enjoyed by McDonalds is in growth overseas. China and India represent major market expansion opportunities, as do other populous markets in Asia -- Vietnam, Indonesia, Thailand and the Philippines. The economic growth in these countries promises to bring hundreds of millions of potential consumers into an income bracket that can afford eating at McDonalds.

The most significant threat to McDonalds is competition in the domestic market. There are an astonishing number of competitors in the U.S. market. As this market matures and begins to stagnate, these competitors will continue to erode McDonald's market share, making it more difficult not only for the firm to turn a profit, but also for the firm to use its domestic income to finance overseas expansion.

Part 3

McDonalds is an exceptional competitor. The company's recent revenue dip on account of the recession notwithstanding, it has long been one of the most exceptional competitors in the global business landscape. For one to find significant fault in this company's business acumen or strategy execution would be a difficult task. With one of the world's most powerful brands, operational excellence and financial strength, the question is not whether McDonald's is a good company to own but rather at what price does one buy in.

McDonalds stock has increased significantly over the course of the past year. The total return for the past year was 31.05% versus a market return of 22.17%. Based on McDonald's beta, the predicted return last year would have been 13.96%. This indicates that the company's stock improved at a much faster rate than it should have given the upward movement of the market as a whole. If McDonald's outperformed last year, then that is a warning flag in terms of its current price level.

The P/E ratio for McDonalds is currently 15.82. This indicates a market prediction of modest growth for the company in the coming year. The market is likely pricing in a return to a positive revenue growth trend -- indeed Q1 revenue grew 10.5% 2010 over 2009, indicating a major growth bounce back. What these figures indicate is that McDonalds may be priced at the high end of its range. The company is trading just off of its 52-week high and indeed is just off of its 10-year high.