Whopper Investments – MCD Case Study
MCD 2004 Case Study—Deliberate Practice Exercise
NOTE: wasn’t able to read the proxy.
Food Service Industry
-makes up virtually all of the business’ results.
-Chipotle Mexican Grill
-Company operates/franchises MCD restaurants
-modeled on selling CHEAP food!
-take advantage of well known MCD brand name.
-franchisees provide capital(equipment,signs,etc and reinvest in business over time)
-company shares in investment by owning/leasing the land/building.
-Franchisees give MCD revenue by paying rent and service fees as % of sales.
–Most arrangements last 20 years. LONG TIME FRAME…might make it difficult to change the agreement if needed…..
Market Share—-MCD has 2.5% of US restaurants and 6.5% of total US restaurant sales….on a fair and equal basis you would assume that 1% of restaurants would get 1% of US restaurant sales, so clearly MCD is getting more than double the avg. volume in its restaurants!
10 yr financials:
Revenue growth: 8.6% compounded annually over 10 yrs
-only 6% compounded annually over last 5 years.
Free Cash Flow Growth: 20% compounded annually over 10 years
-25% compounded annually over 5 years….
-Note, though that these #’s are flawed b/c they result from a sudden jump in FCF(which has been maintained…not a 1 time deal) from 2002 to 2003. Reason? Sudden cut in CAPEX….make sure the CAPEX was simply growth CAPEX and they aren’t shortchanging other areas of the business.
-this is evident in MD&A—they have been improving the business like it’s a turnaround…changing the menus, advertising(which is working—“im lovin it”), and what was clear with FCF—financial discipline—paying down debt, lower CAPEX and lower SG&A % of revenue.
-Note: they judge their management by Return on Incremental Invested Capital..I’m somewhat unfamiliar with the metric but a normalized 31% (41% if impairment charges are included) seems very high.
Geography: US/Europe=35% revenues each.
THE FUTURE:-targeting systemwide sales growth of 3% to 5% .They are planning on expanding their relevance globally.Chipotle business has 400+ restaurants..considering they have systemwide restaurants at 31,000…Chipotle is a very small piece.Expect to use dividends/repurchases to return 1.3B to shareholders.Operating margins have been improving.ROA/ROE is increasing. MCD is a cash cow, very nice business.
Price I’m Willing To Pay:
In 2004 it sold for anywhere between $25 and $33.
1.273B diluted shares outstanding
EPS 3yr=1.22—–15x=18.3……15xFCF=$36 which is barely higher than market highs of the year.
Sustainable OE=3.1B =2.43/share—double EPS
-Growth Expectation-Slightly better than inflation for 10 years and then inflation.
2004-10yr treasury was 4.5%….
I think there might be a flaw in my IV calc….I got 60x OE as my Intrinsic Value assuming 10 year growth of 4% and perpetual growth of 3%…discounting at 6% perpetually. While I can’t find an obvious flaw in my DCF, I think maybe the value of this company was in the fact that FCF was so much higher than net income. Even so, my DCF seems downright silly. Redoing it using FCF instead of OE, I use FCF of 2B(sustainable). Perpetually growing and being discounted at 3% and 6% respectively….my calculation says IV=106B, which means I’d buy at $86/share. At top range of prices for 2004($33), MCD was still a huge steal with a 60% margin of safety according to my calculations. I’d love to see some other valuations so I can see what’s up with my DCF….