Income
Statement and Cash Flow
McDonald’s business model is
rather simple. The company has two sources of revenue: 1) Sales from company
operated McDonald’s restaurants, and 2) Rent and royalty payments from
franchised stores. Sales from the company’s 6,399 operated stores account for
67% of revenue, with franchise fees for the remainder.
What makes this such a great
business for investors is the low cost, predictable cash flow of the franchise
model. Though McDonald’s usually owns the land and building, the locally-owned
restaurant is responsible for operating costs and day to day management. Most
franchise arrangements have 20 year minimums, so once a restaurant opens, MCD
can rely on 20 years of low maintenance, reliable income.
The past 10 years have had an
annual revenue increase of 5.44%, and last year, 2010, saw a revenue increase
of 5.86%. Part of this increase is from the 541 new restaurants opened in 2010,
and the rest is from the strong comparable sales growth MCD has had. 5% global
comparable sales growth in 2010 marks the 8th straight year of such increases.
|
Years
|
Revenue
(in millions)
|
|
2006
|
20,895
|
|
2007
|
22,786.6
|
|
2008
|
23,522.4
|
|
2009
|
22,744.7
|
|
2010
|
24,076.6
|
EPS and FCF per share have
also shown strong growth, averaging 15.4% and 22.9% over the last decade. 2010
saw an EPS increase of 11.4%, from $4.11 to $4.58. Analysts expect MCD to earn
$5.05 in FY 2011 and $5.51 in FY 2012. This would be an increase of 10.3% and
9.1%, respectively. Analysts predict a 5 year growth rate of 9.4%.
Earnings growth comes from a
combination of increased sales and margins, plus the effects of strong stock
buybacks. MCD has averaged to take 4.7% of it’s stock off the market every year
for the past decade. In 2009 the board approved 10 billion dollars in share repurchases,
and to date, they have roughly 6.9 billion dollars left to use, with no
expiration on the cash.
Cash flow has grown from 2.7 billion
in 2001 to 6.3 billion in 2010. Combined with the share buybacks and slowly
increasing capital expenditures, FCF per share has grown faster than EPS. The
$3.86 of free cash flow in 2010 was more than enough to cover the $2.26 in
dividends.
Margins have been trending upwards,
a great sign for the business. I was having trouble finding a reliable gross
margin number, but online research pegs it somewhere in the high 30′s – low 40′s,
percentage wise. As with all food companies, rising commodity prices may affect
MCD in the future, but if any company could deal with increasing raw material
costs, it’s McDonald’s.
For one, they are one of the largest
food buyers in the world, which gives them incredible leverage. Second, 75% of
their grocery bill is comprised of only 10 different commodities. Their
streamlined operation allow them offer a full menu with only a few ingredients,
thereby reducing costs and simplifying purchasing. Third, they have pricing
power. You can buy a hamburger anywhere, but you can only get a Big Mac at
McDonald’s. This allows them the freedom to raise prices in order to offset
higher food costs.
Dividends
MCD is a dividend powerhouse. They
have increased their dividend every year since paying their first one in 1976,
and I believe this will continue into the future. The current quarterly rate of
$0.61 a share equals an annual dividend of $2.44, and the stock currently
yields 3.3%.
Based on dividend history, we can
expect an increase in the fourth quarter of 2011, so the yield is probably a
bit higher. If we estimate a dividend increase of roughly 10% (similar to 2010
increase), that would mean an annual payment of $2.49, and a yield of 3.4%
10 year average annual growth rate
is 28.58%, almost double the EPS growth rate. This was achievable with a mix of
strong earnings growth and an increased payout ratio. Since 2001, the payout
ratio has increased from 18% to 49%. I expect dividend growth to slow in the
coming years, as the increases of the past decade are unsustainable, and the 5
year rolling dividend growth rate is trending down. A 10% growth rate going
forward is reasonable. Any higher, and the payout ratios may head into
dangerous territory.
Balance
Sheet
McDonald’s has a healthy balance
sheet.
The current ratio is 1.49, and debt
is 44% of capital employed. This is a bit higher than I usually like to see,
but interest coverage is a healthy 16.6, and they have over 2 billion in cash.
They should have no problems servicing their debt.
Return on Equity has been trending
upwards, and is rather high, at 34.5%. Some of this is attributable to the
leverage of the company, but most of it is just great management. The past 3
years have kept ROE into the low 30′s, but for most of the 2000′s it was in the
mid teens to low 20′s. The 10 year
average is 21.2%, a very respectable number.
In the franchises of the McDonald's a worthwhile returns on investment in a short time. Easy for people to make decisions and in terms of its financial and sales. Of the table and the graph shows the value and rewards of owning a franchise McDonald's as well. And when it is compared to other
companies. Suggests that opening
a franchise Mac Donald
yield better despite
the high price.
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