McDonald's Stock Analysis
It's about time for another stock analysis. This time I decided to take a look atMcDonalds (MCD). McDonalds closed on Thursday 5/17/12 at $89.62.
Company Background:
McDonald’s Corporation, together with its subsidiaries, franchises and operates McDonald’s restaurants primarily in the United States, Europe, the Asia Pacific, the Middle East, and Africa. The company’s restaurants offer hamburgers and cheeseburgers, Big Mac, Quarter Pounder with cheese, Filet-O-Fish, chicken sandwiches, chicken McNuggets, chicken selects, snack wraps, french fries, salads, shakes, desserts, sundaes, soft serve cones, pies, cookies, soft drinks, coffee, and other beverages, as well as full or limited breakfast menu. As of December 31, 2011, it operated 33,510 restaurants in 119 countries, including 27,075 franchised restaurants and 6,435 company operated restaurants.
DCF Valuation:
Analysts expect McDonalds to grow earnings 9.93% per year for the next five years and I've assumed they can continue to grow at 3.00% per year thereafter. Running these numbers through a DCF analysis with a 10% discount rate yields a fair value price of $112.88. This means that at $89.62 the shares are undervalued by 20%.
Graham Number:
Over the last 12 months, MCD's EPS were $5.35 and it's current book value per share is $14.43. The Graham Number is calculated to be $41.68 which means that at $89.62 the shares are overvalued by 115%.
Average High Dividend Yield:
MCD's average high dividend yield for the past 5 years is 3.45% and for the past 10 years is 3.16%. This gives target prices of $81.14 and $88.63 respectively based on the current annual dividend of $2.80. These are overvalued by 10.5% and fairly valued, respectively.
Average Low PE Ratio:
McDonald's average low PE ratio for the past 5 years is 13.98 and for the past 10 years is 14.15. This would correspond to a price per share of $79.55 and $80.52 respectively based off the analyst estimate of $5.69 per share for the fiscal year ending in December 2012. The 5 year and 10 year low PE price targets are overvalued by 11% and 12.5%, respectively.
Average Low P/S Ratio:
McDonald's average low PS ratio for the past 5 years is 2.74 and for the past 10 years is 2.20. This would correspond to a price per share of $75.92 and $61.08 respectively based off the analyst estimate of $5.69 per share for the fiscal year ending in December 2012. The 5 year and 10 year low PE price targets are overvalued by 18% and 46%, respectively.
Dividend Discount Model:
For the DDM I assumed that MCD will be able to grow dividends for the next 5 years at the minimum of 15% or the lowest of the 1, 3, 5 or 10 year growth rates. In this case that would be 10.67%. After that I assumed MCD can continue to raise dividends by 3.00% annually and used a discount rate of 7.5%. Based on this MCD is worth $89.81 meaning it's fairly valued. While I think that McDonalds can continue to increase it's dividend by more than 3% per year after 5 years it's a good estimate to use to give a conservative valuation.
PE Ratios:
MCD's trailing PE is 16.75 and it's forward PE is 14.33. The PE3 based on the average earnings for the last 3 years is 19.26. Compared to it's industry, MCD seems to be undervalued versus Yum Brands (21.51) and undervalued versus the industry as a whole (22.43). All industry and competitor comparisons are on a TTM EPS basis.
Fundamentals:
MCD's gross margin for FY 2010 and FY 2011 were 40.03% and 39.57% respectively. Their gross margin is very high at ~40% and consistent too. I like to see both of those when looking at potential dividend growth stocks since it means they have pricing power and costs under control. Their net income margin for the same years were 20.55% and 20.38% respectively. I like the net income margin to be at least 10% and preferably rising. McDonalds is doing great on the net profit margin with 20+%. The cash-to-debt ratio for the same years were 0.21 and 0.19. Their cash-to-debt ratio is the only thing really lacking on the fundamentals front.
Share Buyback:
MCD has bought back an average of 3.5% of their shares outstanding annually since 2006.
A negative number for the % change value means shares were bought back by the company and a positive value means the shares outstanding increased.
Dividend Analysis:
McDonalds is a dividend champion with 35 consectutive years of dividend increases. Their average increase has been for the last 1, 3, 5 and 10 years 10.67%, 10.95%, 13.30% and 27.85%. While the dividends have been increasing their annual payout ratios have been pretty consistent since 2002 averaging 43.03%. As we all would, I wish their payout ratio was lower to allow even more room for dividend increases, but a 50% ratio with as much potential earnings growth that McDonalds has, it is definitely safe.
The FCF payout ratio is a little troubling. Since 2003 they've only had 5 years with a FCF payout ratio less than 100% and have been over 100% since 2009. Their average FCF payout ratio since 2003 is 93.51%. Monitoring their FCF and FCF payout ratio will let you know a lot more about the stability of the company since dividends are paid from cash.
Return on Equity and Return on Capital Invested:
MCD's ROE and ROCI have had awesome growth since 2001. I like to see a stable or increasing value for both and they have gone from 18.20% ad 9.5% to 38.20% and 20.7% respectively.
Revenue and Net Income:
Since the basis of dividend growth is revenue and net income growth I've added a new section to my stock analysis. Here you can see McDonalds history of revenue and net income since 2001. MCD's net income margin has started to level off, but not to worry it's at a hefty 20%.
Average Price and EPS:
MCD's average share price has tracked their EPS growth. This means that their PE ratio has been fairly consistent in that time period and hasn't expanded or shrunk considerably. The values are based solely off the average high and low prices for the fiscal year meaning that it doesn't truly show the value opportunities that are present throughout the time period.
Forecast:
The chart shows the historical prices for the previous 10 years and the forecast based on the average PE ratios and the expected EPS values. I have also included a forecast based off a PE ratio that is only 75% of the average low PE ratio for the previous 5 years, 10 years or 16 whichever is least. I like to the look to buy at the 75% Low PE price or lower to provide for additional margin of safety. In this case the target PE is 10.5 which in my opinion is way too low for McDonalds to sell for. If anything it should sell at a premium to most companies. Currently McDonalds is trading at a $30 premium to the forecast entry price. The entry price based on the average low PE10 is $95.07 which means it's selling at a $5.50 discount.
Conclusion:
The average of all the valuation models gives a fair value of $86.61 which means that McDonalds is currently trading at a 3.50% premium to the fair value.
With the recent pullback to under $90 McDonald's is a buy at these levels. The overall macro outlook is poor which is actually good for McDonalds. With a current yield of 3.12% you are getting a solid yield on a company with great growth prospects and has shown it's willingness to increase the dividend. If they can continue to increase dividends by 10% per year for 10 years you're looking at a YOC around 9% in 10 years. I expect the dividend increases to be average higher than 10% over the next 10 years. If it happens to dip down to the 3.50% yield level, price of $80, I would be buying like crazy. It's definitely the time to scale into a position in McDonalds.
Company Background:
McDonald’s Corporation, together with its subsidiaries, franchises and operates McDonald’s restaurants primarily in the United States, Europe, the Asia Pacific, the Middle East, and Africa. The company’s restaurants offer hamburgers and cheeseburgers, Big Mac, Quarter Pounder with cheese, Filet-O-Fish, chicken sandwiches, chicken McNuggets, chicken selects, snack wraps, french fries, salads, shakes, desserts, sundaes, soft serve cones, pies, cookies, soft drinks, coffee, and other beverages, as well as full or limited breakfast menu. As of December 31, 2011, it operated 33,510 restaurants in 119 countries, including 27,075 franchised restaurants and 6,435 company operated restaurants.
DCF Valuation:
Analysts expect McDonalds to grow earnings 9.93% per year for the next five years and I've assumed they can continue to grow at 3.00% per year thereafter. Running these numbers through a DCF analysis with a 10% discount rate yields a fair value price of $112.88. This means that at $89.62 the shares are undervalued by 20%.
Graham Number:
Over the last 12 months, MCD's EPS were $5.35 and it's current book value per share is $14.43. The Graham Number is calculated to be $41.68 which means that at $89.62 the shares are overvalued by 115%.
Average High Dividend Yield:
MCD's average high dividend yield for the past 5 years is 3.45% and for the past 10 years is 3.16%. This gives target prices of $81.14 and $88.63 respectively based on the current annual dividend of $2.80. These are overvalued by 10.5% and fairly valued, respectively.
Average Low PE Ratio:
McDonald's average low PE ratio for the past 5 years is 13.98 and for the past 10 years is 14.15. This would correspond to a price per share of $79.55 and $80.52 respectively based off the analyst estimate of $5.69 per share for the fiscal year ending in December 2012. The 5 year and 10 year low PE price targets are overvalued by 11% and 12.5%, respectively.
Average Low P/S Ratio:
McDonald's average low PS ratio for the past 5 years is 2.74 and for the past 10 years is 2.20. This would correspond to a price per share of $75.92 and $61.08 respectively based off the analyst estimate of $5.69 per share for the fiscal year ending in December 2012. The 5 year and 10 year low PE price targets are overvalued by 18% and 46%, respectively.
Dividend Discount Model:
For the DDM I assumed that MCD will be able to grow dividends for the next 5 years at the minimum of 15% or the lowest of the 1, 3, 5 or 10 year growth rates. In this case that would be 10.67%. After that I assumed MCD can continue to raise dividends by 3.00% annually and used a discount rate of 7.5%. Based on this MCD is worth $89.81 meaning it's fairly valued. While I think that McDonalds can continue to increase it's dividend by more than 3% per year after 5 years it's a good estimate to use to give a conservative valuation.
PE Ratios:
MCD's trailing PE is 16.75 and it's forward PE is 14.33. The PE3 based on the average earnings for the last 3 years is 19.26. Compared to it's industry, MCD seems to be undervalued versus Yum Brands (21.51) and undervalued versus the industry as a whole (22.43). All industry and competitor comparisons are on a TTM EPS basis.
Fundamentals:
MCD's gross margin for FY 2010 and FY 2011 were 40.03% and 39.57% respectively. Their gross margin is very high at ~40% and consistent too. I like to see both of those when looking at potential dividend growth stocks since it means they have pricing power and costs under control. Their net income margin for the same years were 20.55% and 20.38% respectively. I like the net income margin to be at least 10% and preferably rising. McDonalds is doing great on the net profit margin with 20+%. The cash-to-debt ratio for the same years were 0.21 and 0.19. Their cash-to-debt ratio is the only thing really lacking on the fundamentals front.
Share Buyback:
MCD has bought back an average of 3.5% of their shares outstanding annually since 2006.
A negative number for the % change value means shares were bought back by the company and a positive value means the shares outstanding increased.
Dividend Analysis:
McDonalds is a dividend champion with 35 consectutive years of dividend increases. Their average increase has been for the last 1, 3, 5 and 10 years 10.67%, 10.95%, 13.30% and 27.85%. While the dividends have been increasing their annual payout ratios have been pretty consistent since 2002 averaging 43.03%. As we all would, I wish their payout ratio was lower to allow even more room for dividend increases, but a 50% ratio with as much potential earnings growth that McDonalds has, it is definitely safe.
The FCF payout ratio is a little troubling. Since 2003 they've only had 5 years with a FCF payout ratio less than 100% and have been over 100% since 2009. Their average FCF payout ratio since 2003 is 93.51%. Monitoring their FCF and FCF payout ratio will let you know a lot more about the stability of the company since dividends are paid from cash.
Return on Equity and Return on Capital Invested:
MCD's ROE and ROCI have had awesome growth since 2001. I like to see a stable or increasing value for both and they have gone from 18.20% ad 9.5% to 38.20% and 20.7% respectively.
Revenue and Net Income:
Since the basis of dividend growth is revenue and net income growth I've added a new section to my stock analysis. Here you can see McDonalds history of revenue and net income since 2001. MCD's net income margin has started to level off, but not to worry it's at a hefty 20%.
Average Price and EPS:
MCD's average share price has tracked their EPS growth. This means that their PE ratio has been fairly consistent in that time period and hasn't expanded or shrunk considerably. The values are based solely off the average high and low prices for the fiscal year meaning that it doesn't truly show the value opportunities that are present throughout the time period.
Forecast:
The chart shows the historical prices for the previous 10 years and the forecast based on the average PE ratios and the expected EPS values. I have also included a forecast based off a PE ratio that is only 75% of the average low PE ratio for the previous 5 years, 10 years or 16 whichever is least. I like to the look to buy at the 75% Low PE price or lower to provide for additional margin of safety. In this case the target PE is 10.5 which in my opinion is way too low for McDonalds to sell for. If anything it should sell at a premium to most companies. Currently McDonalds is trading at a $30 premium to the forecast entry price. The entry price based on the average low PE10 is $95.07 which means it's selling at a $5.50 discount.
Conclusion:
The average of all the valuation models gives a fair value of $86.61 which means that McDonalds is currently trading at a 3.50% premium to the fair value.
With the recent pullback to under $90 McDonald's is a buy at these levels. The overall macro outlook is poor which is actually good for McDonalds. With a current yield of 3.12% you are getting a solid yield on a company with great growth prospects and has shown it's willingness to increase the dividend. If they can continue to increase dividends by 10% per year for 10 years you're looking at a YOC around 9% in 10 years. I expect the dividend increases to be average higher than 10% over the next 10 years. If it happens to dip down to the 3.50% yield level, price of $80, I would be buying like crazy. It's definitely the time to scale into a position in McDonalds.
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