In this article, let's take a look at McDonald's Corp. (MCD, Financial), a $92.12 billion market cap company that is the largest fast-food restaurant company in the world, with more than 35,000 restaurants in 119 countries.
Bright outlook
McDonald's experienced a strong growth over the past 20 years. Key drivers of growth were factors such as its strong brand, a franchisee system and international expansion. But in recent years that growth has diminished due to the competition, the general economic environment, as well as evolving consumer tastes. In order to offset this, management has focused on a new approach "to increase its relevance with customers and drive guest traffic," including a modernized restaurant experience and comprehensive digital ordering, payments and marketing strategy. One of the last and profitable strategies was the “Menu Innovation,” which has played a role in its productivity. Last year, those innovations were based on chicken, premium beef, breakfast and beverages. For example, a firm's beverage initiatives are the McCafe coffee and real fruit smoothies.
Moreover, the company expects to continue to execute its corporate strategy, "Plan to Win," which was laid out several years ago. The plan has five pillars: People, Products, Place, Price and Promotion.
Thinking about new initiatives, the market leader wants to improve its operations. In that way, it plans to implement more decentralized decisions to be closer to the customer.
Principal risk
More than half of total operating profits come from Europe and APMEA segments. When thinking about the major risks, we believe economic fluctuations in these regions as well as exchange rate are the principal ones. Of course, an increase in labor costs could hurt the bottom line.
Revenues, margins and profitability
Looking at profitability, revenue declined by 4.6% and led earnings per share decreased in the most recent quarter compared to the same quarter a year ago ($1.09 vs $1.52). During the past fiscal year, the company increased its bottom line. It earned $5.56 versus $5.36 in the previous year. For the next year, Wall Street expects a contraction of 10.9% in earnings ($4.96 versus $5.56). This is not good for investors.
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| MCD | Mac Donalds | 32.80 |
| SBUX | Starbucks Corp | 41.95 |
| BKW | Burger King Worldwide Inc. | 12.15 |
| Â | Industry Median | 10.50 |
The company has a current ROE of 32.80% which is higher than the one exhibit by Burger King (BKW, Financial). In general analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. So for investors looking those levels or more, Starbucks (SBUX, Financial) could be the option. It is very important to understand this metric before investing, and it is important to look at the trend in ROE over time.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 18.6x, trading at a discount compared to an average of 31.2x for the industry. To use another metric, its price-to-book ratio of 6.8x indicates a premium versus the industry average of 3.57x while the price-to-sales ratio of 3.4x is above the industry average of 1.27x.
As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10.000 five years ago, today you could have $18.806, which represents a 13.5% compound annual growth rate (CAGR).
Final comment
For the upcoming future, we expect this industry to increase competition on price and product differentiation. Moreover, the PE relative valuation and the return on equity that significantly exceeds the industry average and make me feel bullish on this stock.
In a next article we are going to calculate the intrinsic value and compare it with the actual trading price.
Hedge fund gurus like Jean-Marie Eveillard (Trades, Portfolio), Jeremy Grantham (Trades, Portfolio), Bill Nygren (Trades, Portfolio) and Ruane Cunniff (Trades, Portfolio) added this stock to their portfolios, as well as Diamond Hill Capital (Trades, Portfolio) and HOTCHKIS & WILEY. I would advise fundamental investors to consider adding McDonald´s to their long-term portfolio.
Disclosure: Omar Venerio holds no position in any stocks mentioned
