Analysts: Alexa Bowen, Blake Porter and Kennedy White Washburn University Applied Portfolio Management Report Date: 4/19/2016 Market Cap (mm) $111,779 Annual Dividend $3.44 2‐Yr Beta (S&P 500 Index) 0.55 McDonald's Corp. Return on Capital 17.3% Dividend Yield 2.9% Annualized Alpha 19.8% Compared With: EPS (ttm) $4.82 Price/Earnings (ttm) 24.7 Institutional Ownership 6.6% Starbucks Corporation Current Price $118.99 Economic Value‐Added (ttm) $3,429 Short Interest (% of Shares) 3.7% Yum! Brands, Inc. 12‐mo. Target Price $130.00 Free Cash Flow Margin 4.1% Days to Cover Short 4.7 and the S&P 500 Index Business Description Total Revenue ‐2.7% Free Cash Flow ‐36.3% EBIT ‐4.2% Total Invested Capital 5.0% NOPAT ‐3.5% Total Assets 2.3% Earnings Per Share ‐3.8% Economic Value‐Added ‐6.7% Dividends Per Share 6.2% Market Value‐Added 12.1% 2011 2012 2013 2014 2015 30.7% 30.3% 30.3% 28.9% 28.9% N/A 14.5% 14.7% 24.8% 4.1% 5.3% 6.1% 5.8% 5.2% 4.1% 2.5% 3.3% 3.2% 3.5% 2.9% 2011 2012 2013 2014 2015 5.33 5.41 5.59 4.85 4.82 2.53 2.87 3.12 3.28 3.44 5.52 5.60 5.81 5.22 5.41 N/A 3.97 4.14 6.95 1.10 Datasource: Capital IQ NOPAT Free Cash Flow Earnings Yield Dividend Yield Per Share Metrics Earnings Dividends Free Cash Flow Margin McDonald’s Corporation operates and franchises McDonald's restaurants in the United States, Europe, the Asia/Pacific, the Middle East, Africa, Canada, and Latin America. The company's restaurants offer various food products, soft drinks, coffee, and other beverages. As of December 31, 2015, it operated 36,525 restaurants, including 30,081 franchised restaurants comprising 21,147 franchised to conventional franchisees, 5,529 licensed to developmental licensees, and 3,405 licensed to foreign affiliates; and 6,444 company‐operated restaurants. The company was founded in 1940 and is based in Oak Brook, Illinois. Investment Thesis After analyzing MCD's historical metrics and projecting future growth, we have found multiple reasons to recommend a sell decision. The $5 billion drop in cash flow, combined with negative revenue growth in 2014 and 2015, and projected negative revenue growth into 2018, show that MCD's fundamental strength has begun to fade. President of McDonald's USA sector spells out three main issues for the company: 1) The pricing gap between value and premium is too wide. 2) Slow reaction times to changing taste preferences. 3) Consumers are shifting toward healthier foods. The hiring of the new CEO and implementation of his turnaround plan has promised increased margins, however we believe these margins are not sufficient to sustain the long‐term growth of the company. ANNUALIZED 3‐YEAR CAGR Margins and Yields Operating Margin MCD McDonald's Corp. Sector: Consumer Discretionary SELL ‐10% ‐5% 0% 5% 10% 15% 20% 25% 30% 35% MCD ^SPX ‐20% ‐10% 0% 10% 20% 30% 40% MCD SBUX YUM 0 20 40 60 80 100 120 2012 2013 2014 2015 Price/Earnings Price/Free Cash Flow $0 $1,000 $2,000 $3,000 $4,000 $5,000 $6,000 $7,000 $8,000 $9,000 2011 2012 2013 2014 2015 EBIT Net Operating Profit After Tax $0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 $0 $500 $1,000 $1,500 $2,000 $2,500 $3,000 $3,500 $4,000 $4,500 $5,000 2011 2012 2013 2014 2015 Economic Value‐Added Market Valued‐Added 0% 10% 20% 30% 40% 50% 60% 70% 2011 2012 2013 2014 2015 ROA ROE ROIC
Analyst Comments: Both MCD and SBX have managed to have stable gross and operating margins. If these margins are high, it indicates that that a greater portion of a company's revenue is available to flow toward profits and free cash flows. In comparison to SBX, MCD maintains a higher gross margin and also has a smaller percentage of expenses that are incurred between the gross margin and operating margin. While MCD did experience a miniscule decrease in their operating margin in both 2014 and 2015, we should still be reasonably confident about the efficiency of MCD's operations. The net profit margin of MCD follows a similar trajectory in regards to 2014 and 2015 where there was a slight decrease, which tells us that some of the income statement efficiencies from 2011 to 2013 didn't make it all the way to the bottom line in the most recent two years. Perhaps the biggest area of concern is in the free cash flow margin, which is a key variable in terms of value creation. In stark contrast to 2014, the FCF margin in 2015 is a a four year low. This is a major red flag in terms of the company's ability to create value in the future.
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1. Margins and Profitability MCD, Page 3 of 28 Copyright Robert A. Weigand, Ph.D., 2016
= Return on Equity 38.2% 35.7% 34.9% 37.0% 63.9% = Return on Equity 28.4% 27.1% 0.2% 39.2% 47.4%
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Return on Equity MCD SBUX
Analyst Comments: From 2011 to 2014, the return on equity (ROE), which measure the dollars of accounting profit generated ina fiscal year relative to the capital contributed toward financing the firm by sharehoilders, was quite stable and it never went above 39% and never below 34%. In 2015, however, the ROE jumped by almost 30%. This dramatic increase was due in large part to the more than doubling of the equity muliplier. The equity multiplier increases as the firm finances its assets with more debt‐ or liability‐based financing, and decreases when the firm is financed with more shareholder equity. A look at the balance sheet reveals a significant increase in total debt and a corresponding decrease in equity. With these two things occuring (and no significant change to total assets), it signals a change in the way MCD is being financed.
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1. Margins and Profitability MCD, Page 4 of 28 Copyright Robert A. Weigand, Ph.D., 2016
MCD McDonald's Corp. SBUX Starbucks Corporation
Multiples and Yields 2011 2012 2013 2014 2015 Multiples and Yields 2011 2012 2013 2014 2015
Analyst Comments: As mentioned in the margins sections, free cash flow is a four year low. From 2011 to 2014, the Price/Free Cash Flow, which measure the stock price relative to free cash flows, is stable which is a result of both a steady stock price and consistent levels of free cash flows. Conversely, in 2015 we see a significnatly higher stock price combited a with a four year low in free cash flows. While the graph comparing the P/E rati of MCD and SBX isn't particularly telling (mostly due to SBX's year in 2013 where they recorded virtually no income, resulting in a hyper‐inflated P/E ratio), we can see another troubling sign from MCD in terms of their P/E ratio in 2015. MCD's P/E ratio increases by over 5 points due to a decrease in net income and an increase in their stock price. This tells us that MCD's earnings are not keeping pace with the stock price. The correspondance in the P/E ratio and the P/FCF ratio suggests that there may be some concern regarding whether MCD's earnings are backed up by tagible free cash flows.
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2. Relative Valuation and Debt MCD, Page 5 of 28 Copyright Robert A. Weigand, Ph.D., 2016
MCD McDonald's Corp. SBUX Starbucks Corporation
Liquidity and Debt 2011 2012 2013 2014 2015 Liquidity and Debt 2011 2012 2013 2014 2015
Current Ratio 1.25 1.45 1.59 1.52 3.27 Current Ratio 1.83 1.90 1.02 1.37 1.19
Quick Ratio 1.22 1.41 1.55 1.48 3.23 Quick Ratio 1.36 1.34 0.81 1.01 0.83
Days Sales Outstanding 18.04 18.21 17.14 16.15 18.65 Days Sales Outstanding 12.06 13.36 13.78 14.00 13.70
Total Debt to Assets 36.8% 38.5% 38.6% 43.7% 63.6% Total Debt to Assets 7.5% 6.7% 11.3% 19.0% 18.9%
Long‐Term Debt to Equity 84.4% 89.1% 88.3% 116.3% 340.4% Long‐Term Debt to Equity 12.5% 10.8% 29.0% 38.9% 40.3%
Times Interest Earned 16.83 16.18 16.14 13.76 11.52 Times Interest Earned 45.78 54.64 78.55 43.57 47.70
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Analyst Comments: In 2015, MCD's experienced a spike in both the current ratio, which provides a check to make sure the company's short‐term liabilities can be covered by liquid short‐term assets, and the quick ratio, which is the same as the current ratio except it subtracts inventory because some of the inventory may be outdated or slow selling as a result of poor economic conditions. The high ratios, which result from MCD more than tripling the company's cash position, raises questions about why they feel the need to be so liquid. When looking at the total debt to assets ratio, we see a gradual increase and the most significant increase occuring in 2015. This ratio is important in terms of assessing MCD's solvency. Firms can become overleveraged if they get in a habit of raising new debt to refinance old debt. A $10 billion increase in long‐term debt in 2015 in the primary cause for the uptick in the ratio. Lastly, we see a similar increase in the MCD's long‐term debt to equity. The increase in 2015 is also due to the increase in long‐term debt realtive to a stable amount of equity. Ultimately, these ratios which reveal a high level of debt relative to both assets and equity raises concerns about the firm being overleveraged and exposed to risk such as increasing interest rates.
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2. Relative Valuation and Debt MCD, Page 6 of 28 Copyright Robert A. Weigand, Ph.D., 2016
MCD McDonald's Corp. SBUX Starbucks Corporation
Total Invested Capital 2011 2012 2013 2014 2015 Total Invested Capital 2011 2012 2013 2014 2015
Total Cash and ST Investments 2,345 2,340 2,799 2,081 7,686 Total Cash and ST Investments 2,051 2,037 3,234 1,844 1,611
NOPAT per Share $5.52 $5.60 $5.81 $5.22 $5.41 NOPAT per Share $0.70 $0.80 $1.47 $1.21 $1.59
Free Cash Flow per Share N/A $3.97 $4.14 $6.95 $1.10 Free Cash Flow per Share N/A $0.36 $0.49 $1.97 $1.42
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Analyst Comments: While a stable net operating profit after tax (NOPAT), which measures the after‐tax operating profit a firm generates before accounting for interest payments, over the past four years is a positive sign, we would prefer to see a larger percentage of MCD's NOPAT make it down to the free cash flow (FCF). The discrepentcy between the NOPAT and FCF is due to the large change in total invested capital. The change comes from a huge increase in the net operative working cpaital (NOWC), which was inflated due a much stronger cash position from MCD in 2015. As mentioned in the relative valuation and debt section, a severely low FCF in 2015 raises serious concerns about future value creation.
3. Value Creation and DCF Model MCD, Page 7 of 28 Copyright Robert A. Weigand, Ph.D., 2016
MCD McDonald's Corp. SBUX Starbucks Corporation
Cost of Capital 2015 Weight % Cost Weighted % Cost of Capital 2015 Weight % Cost Weighted %
Analyst Comments: When looking at the comparison of the economic value‐added (EVA), which is a year‐by‐year meausre of how much economic profit the firm has created, and the market value added (MVA), which is often referred to as the ultimate bottom line for a publicly traded company, we see a decrease in EVA in both 2015 while we see a contrasting increase in the MVA those years. If we compare the return on invested capital (ROIC) of MCD and SBX, we see something quite different. For MCD, ROIC has been steadily decreasing since 2011 and for SBX, ROIC has been steadily increasing since 2011. One explanation for this is that SBX has been running a much lower total capital/share, instead of generating higher NOPAT/share.
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3. Value Creation and DCF Model MCD, Page 8 of 28 Copyright Robert A. Weigand, Ph.D., 2016
Intrinsic Value Model 2011 2012 2013 2014 2015 Intrinsic Value Model 2011 2012 2013 2014 2015
PV of Future FCFs 37,628 35,732 33,607 28,678 29,252 PV of Future FCFs 27,375 28,801 30,141 29,353 29,353
+ Value of Non‐Oper. Assets 2,336 2,336 2,799 2,078 7,686 + Value of Non‐Oper. Assets 2,051 2,037 3,234 1,844 1,611
= Total Intrinsic Firm Value 39,964 38,068 36,406 30,756 36,937 = Total Intrinsic Firm Value 29,426 30,838 33,375 31,197 30,965
− Total Debt 12,148 13,633 14,142 14,943 24,126 − Total Debt 550 550 1,299 2,048 2,348
= Intrinsic Value of Equity 27,816 24,436 22,264 15,813 12,812 = Intrinsic Value of Equity 28,876 30,289 32,076 29,149 28,617
÷ Total Weighted Shares 1,032 1,010 998 981 939 ÷ Total Weighted Shares 1,497 1,509 1,499 1,506 1,496
= Per Share Intrinsic Value $26.95 $24.19 $22.30 $16.13 $13.64 = Per Share Intrinsic Value $19.29 $20.07 $21.41 $19.35 $19.13
vs. Year‐End Stock Price $100.33 $88.21 $97.03 $93.70 $118.14 vs. Year‐End Stock Price $18.65 $25.36 $38.67 $37.59 $57.99
Over (Under) Valuation/Share $73.38 $64.02 $74.73 $77.57 $104.50 Over (Under) Valuation/Share ($0.65) $5.28 $17.26 $18.23 $38.86
% Over (Under) Valued 272.3% 264.6% 335.1% 481.0% 766.2% % Over (Under) Valued ‐3.4% 26.3% 80.6% 94.2% 203.1%
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MVA per Share MCD SBUX
Analyst Comments: Based on our model, we see MCD's year‐end stock price and their per share intrinsic value heading in opposite directions which should be a sign of concern to investors. The resulting intrisic value of our model shows us a value of $2.15, which is essentially zero. A year‐end stock price that far exceeds the intrinsic value gives MCD a resulting overvaluation. In years past, MCD has been similarly overvalued, but in 2015 it reached a new degree of overvaluation‐ it is 5,287.6% overvalued. While SBX is similarly overvalued, it is by a significantly lesser degree. One area of good news is the margin between the ROIC and the weighted average cost of captial (WACC). After adjusting the beta up to .6, we are left with a WACC of 5.614%. As you can see on the graph, in each year the ROIC exceeds the WACC which means that value is being created. The only worry for the future would be that in each of the past five years, the margin between the ROIC and the WACC has gotten smaller. Aside from the ROIC and the WACC, in terms of value creation, MCD is dangerously overvalued.
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3. Value Creation and DCF Model MCD, Page 9 of 28 Copyright Robert A. Weigand, Ph.D., 2016
Altman Z‐Score Scale: Safe Zone = Z > 2.9, Grey Zone = 1.23 < Z < 2.9, Distress Zone = Z < 1.23 Altman Z‐Score Scale: Safe Zone = Z > 2.9, Grey Zone = 1.23 < Z < 2.9, Distress Zone = Z < 1.23
3. Value Creation and DCF Model MCD, Page 10 of 28 Copyright Robert A. Weigand, Ph.D., 2016
% of sales 0.4% 0.4% 0.4% 0.4% 0.4% 0.4% % of sales 0.4% 0.4% 0.4% 0.4% 0.4%
Net PPE 22,835 24,677 25,747 24,558 23,118 Net PPE 23,172 23,353 23,551 23,600 23,740
% of sales 84.6% 89.5% 91.6% 89.5% 91.0% 89.2% % of sales 97.0% 104.0% 114.0% 112.0% 111.0%
Total Assets 32,990 35,387 36,626 34,227 37,939 Total Assets 35,593 33,682 30,988 27,604 26,735
% of sales 122.2% 128.4% 130.3% 124.7% 149.3% 131.0% % of sales 149.0% 150.0% 150.0% 131.0% 125.0%
Payables and Accruals 2,858 3,094 2,902 2,573 2,768 Payables and Accruals 2,508 2,358 2,169 2,213 2,246
% of sales 10.6% 11.2% 10.3% 9.4% 10.9% 10.5% % of sales 10.5% 10.5% 10.5% 10.5% 10.5%
ST Debt plus LT Debt 12,148 13,633 14,142 14,943 24,126 ST Debt plus LT Debt 25,083 22,455 19,626 18,965 18,180
% of sales 45.0% 49.5% 50.3% 54.5% 94.9% 58.8% % of sales 105.0% 100.0% 95.0% 90.0% 85.0%
Total Equity 14,390 15,294 16,010 12,853 7,088 Total Equity 5,733 4,940 4,132 4,214 4,278
% of sales 53.3% 55.5% 57.0% 46.8% 27.9% 48.1% % of sales 24.0% 22.0% 20.0% 20.0% 20.0%
April 19, 2016
Forecasted Income Statement Drivers
Forecasted Balance Sheet Drivers
Historical Income Statement Drivers
Historical Balance Sheet Drivers
Analyst Comments:Income Statement:USA Pres Mike Andres spells out 3 main issues: 1. The pricing gap between value and premium products is too wide 2. Slow reaction times to changing tase preferences 3. Consumers are shifting towards healthier foods.(Morningstar pg. 4) Part of the turnaround plan being put into action (that will be discussed further) is refranchising 4000 locations to be completed in 2018 (hence the increased revenue growth in 2019) the purpose of which is to "optimize its restaurant ownership mix, generate more stable and predictable revenue and cash flow streams, and operate with a less resource‐ intensive structure" (10K pg.25) These problems are expected to cause a decreae in revenues in the next 3 years, will cause EBIT to increase regardless of the falling revenues. Only offset somewhat by increased minimum wages and healthcare costs (Obamacare) (S&P pg.4) Share repurchasing to increase shareholder value is part of the turnaround program, and is projected to continue for the next 5 quarters. (Argus pg.5) MCD has increased dividends consistently in the past, coupled with the impressive margins and buyback program this isn't looking to slow anytime soon. All 3 analyst reports (S&P, Argus, and Morningstar) have impressive (and more exaggerated) forecasted dividends.Balance Sheet Cash + ST Investments saw a sharp rise in 2015 due to higher net borrowings to be used for the share repurchasing program. This cash can also be expected to be returned to investors via dividends. The % is expected to remain steady into 2017 as McDonald's continues their accelerated share repurchase program. Total Receivables and Inventory will remain at the long‐term average rate as there were no compelling reasons to change them. Net PPE will remain at the long‐term average rate as revenue and new restaurant developments will grow at the same rate. Total Assetswill increase and then slow as it models the trend in Cash + ST Investments. ST Debt plus LT Debt will see an increase into 2016/2017 as MCD will need to finance the repurchase program. Total Equity can be expected to decrease due to MCD aggressively repurchasing shares.
4. Forecasting and Valuation MCD, Page 11 of 28 Copyright Robert A. Weigand, Ph.D., 2016
McDonald's Corp. McDonald's Corp.
Total Invested Capital 2011 2012 2013 2014 2015 Total Invested Capital 2016E 2017E 2018E 2019E 2020E
Cash and ST Investments 2,345 2,340 2,799 2,081 7,686 Cash and ST Investments 7,166 6,961 5,165 2,739 2,780
NOPAT per Share $5.52 $5.60 $5.81 $5.22 $5.41 NOPAT per Share $5.55 $5.67 $5.61 $5.82 $6.09
Free Cash Flow per Share N/A $3.97 $4.14 $6.95 $1.10 Free Cash Flow per Share $5.95 $5.61 $7.31 $8.51 $5.91
Historical Performance Forecasted Performance
Historical Performance Forecasted Performance
Analyst Comments: Tot Rev vs. EBIT: Regardless of their falling revenues, their "turnaround plan" promises increasing margins across the board. Steps for the plan incluse reorganizing the company
based on maturity and competitive positions, refranchising 4000 locations, and $500 mil in SG&A expense reduction. They also plan to streamline their menu, make more localized decisions, improve their consumer technologies, and return more cash to shareholders; helping MCD better align themselves with current consumer preferences and fix pricing issues. (Morningstar pg.1 & Argus pg.2)EPS and DPS are rising together.OPM begins to close in on GPM as SG&A expenses drastically decrease with restructuring efforts.
Analyst Comments: DDM: If an investor were purchase MCDat it’s current market price of $118.99, hold it for 4 years while reinvesting dividends into additional shares of MCDand then sell at the
DDM’s estimated intrinsic value, their average annual return would be 2.2%. The dividend alone has an intrinsic value of $103.23, which means over 85% of the current price is supported by the present value of the forecasted dividend stream. FCF: Because of the franchise and affiliate structure of the company (now making up 82% of the company and expected to grow to 95% over the long term) FCF's are streamed in consistently from royalties and rent, even in challenging economic times with minimal capital needs in return. (Morningstar pg.3)NOPAT: A slow, but steady increase can be seen for the NOPAT from years 2015‐2020, as MCD does an effective job of increasing their margins.
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4. Forecasting and Valuation MCD, Page 13 of 28 Copyright Robert A. Weigand, Ph.D., 2016
Analyst Comments: ROIC: Similar to FCF in regards to the cash streams from the comany's structure, ROIC increases consistently from 2015 on. Seeing as MCD owns 45% of the land their restaraunts
reside on, their returns are "generated on a higher invested capital base" than it's competitors ‐ creating what Morningstar refers to as a "competitive buffer."As ROIC rises, the margin between that and WACC is growing into the forseeable future, meaning value is being created over this time.Intrinsic Value is forecasted to slowly increase in upcoming years ‐ consistent with the current undervaluation of the stock.Price‐FCF: A spike in 2015 Price to FCF can be attributed to MCD share price jumping from $93.70 to $118.14, thus increasing the numerator in the equation of Price‐FCF. In conjunction with the rise in share price, the FCF margin also fell extremely from 25% to 4%.
