mcdonald’s (mcd) september 10, 2020 · 2020. 12. 4. · year franchise agreement, mcd maintains...

Important disclosures appear on the last page of this report.

The Henry Fund

Henry B. Tippie College of Business Jack Simpson [[email protected]] McDonald’s (MCD) September 10, 2020

Consumer Discretionary – Fast Food Restaurants Stock Rating Buy

Investment Thesis Target Price $240-260 The Henry Fund is bullish on McDonalds and currently recommend a BUY for McDonald’s. MCD has continued to put a focus on improving margins as industry growth has slowed in recent years. We believe that MCD’s leading position in technological advances will continue to separate the company from its peers. The company continues to diversify revenue streams away from selling just hamburgers as they continue to switch to strong franchise model. Drivers of Thesis • McDonald’s has had strong same store sales growth over the past 5 years

with 2019 reaching 5.9%. We believe MCD will be able to continue doing this through technological advancements and increased delivery and have forecast a 5-year CAGR of 1.97% over the next 5-years.

• Reaching 95% franchised restaurants in 2024 will continue to expand margins helping the company become more profitable, while continuing to diversify revenue streams into rent and royalties from franchisees.

• MCD continues to be a technological leader in the industry which will drive future sales and expand operating margins from 43% in 2019 to 48.3% in 2024 through automating processes and increases the number of orders.

Risks to Thesis • MCD has limited room to further grow total revenues, if MCD is unable to

deliver same store sales growth above other competitors we believe this may revise our current rating.

• We have projected the operating margin to increase by 5.3% over the next five years. If the company is not able to improve margins by at least 3.5%, it might change our recommendation to a sell.

Henry Fund DCF $256 Henry Fund DDM $273 Relative Multiple $260 Price Data Current Price $219 52wk Range $124 – 226 Consensus 1yr Target $222 Key Statistics Market Cap (B) $162.76 Shares Outstanding (M) $744.1 Institutional Ownership 68.7% Beta 0.92 Dividend Yield 2.3% Est. 5yr Growth 5.4% Price/Earnings (FY19) 25.2 Price/Earnings (FY20E) 37.8 Price/Sales (FY19) 7.1 Price/Sales (FY20E) 8.6 Profitability Operating Margin 41.8% Net Margin 28.6% Return on Assets (TTM) 15.0%

Earnings Estimates Year 2017 2018 2019 2020E 2021E 2022E EPS $6.43 $7.59 $7.96 $7.53 $8.48 $9.04

Growth Consensus

18.3% 9.4% 12.9% -11.1% $6.83

48.2% $8.15

10.8% $8.95

12 Month Performance Company Description

McDonald’s was founded in 1940 and is considered a pioneer in the fast food restaurant industry. Currently, MCD is the largest fast food chain in the world. The company operates in 119 countries around the globe and has over 93% of stores franchised. The company operates in three different geographic segments: U.S., International Operated Markets, and International Developmental Licensed Markets & Corporate. Today, MCD is one of the most well-known brands in the world.

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COMPANY DESCRIPTION

McDonald’s is the largest fast-food chain globally with one of the best-known brand names which continues to position McDonalds as an industry leader in the quick service restaurant industry. As of year-end 2019, MCD had 38,695 restaurants in 119 countries. On a total restaurant count, MCD is the second largest fast food restaurant chain behind Subway. The below graph demonstrates the top five largest fast food chains by total number of restaurants in 2019.

Source: Company 10K’s

Of MCD’s 38,965 restaurants, 36,059 were franchised, which accounts for 93% of McDonald’s restaurants world-wide.

Source: Company 10K

As seen, the company is primarily a franchisor and we see this as being paramount to continuing to expand the brand while increasing customer experience and driving further profitability as the company operates in the mature stage of its life cycle. MCD still operates 7% of its stores as company owned, which is an important aspect for MCD to be able to continue growing the brand, introduce new products quicker, and contributes significantly to the company’s ability to act as a credible franchisor.

MCD differs significantly from its peers in that not only do they get sales from restaurant operations, but a significant portion of the company’s revenues comes in the form of rent from leasing the company’s real estate properties to its franchisee’s.

Company Operated Stores

As of year-end 2019, McDonald’s operated 6.9% of the company’s restaurants. This included 692 stores in the U.S. and 1,962 internationally. However, the company has been continuing to sell-off company operated stores in order to achieve the company’s goal of a 95% franchised store business model. We believe that the company will want to keep 5% franchised in order to maintain some control over franchisees. The following table demonstrates the gradual transition MCD has been making in the store type operating model. As seen, MCD has decreased the percentage of company operated stores from 8.2% in 2017, to 6.9% in 2019.

Source: Company 10K

As shown, the Henry Fund believes that MCD will be able to reach the company’s goal of only 5% company-operated stores by 2024. We have projected total company-operated stores to be 626 in the U.S. and 1,773 internationally in 2024.

Since 2017, McDonald’s has been slowing their decrease in company operated stores. As the company continues to decrease the number of company-operated stores, there are less restaurants to flip to the franchised model. Due to this, we have modeled a slower transition rate from company-operated to franchised in our forecast period.

Unlike franchised stores, company operated stores offer much higher revenues as the company keeps all income from these stores. On the contrary, company-operated stores have significantly lower margins as the company is accountable for all expenses related to these restaurants. Due to the mature life cycle MCD is currently in, the company is focusing more on margin expansion, rather than revenue growth. In order to increase margins, the company will continue to switch to a franchised model going forward, especially considered how strong the company brand already is. This is a reasonable to assume as companies begin focusing on margins to increase profitability in mature markets. Specifically, this is seen in the large decrease in company operated stores seen in the U.S. in the past three years. We expect MCD to keep the company’s key stores as company operated. This will include their most profitable stores and well as key stores to introduce new products to test.

Franchised Stores

Franchise stores make-up the remaining 93% of restaurants. This includes 13,153 U.S. stores and 22,887 international stores. We have forecasted that franchised stores will reach 95% by 2024. We have forecasted that U.S. franchised stores will increase very slightly and reach 13,351 by 2024.

Franchised store revenues represent three separate income streams for the company which include rent, royalties, and initial fees. MCD has allocated consideration in the franchise contracts among lease and non-lease components through; rental income (lease), royalty income (non-lease) and initial fee (non-lease).

Franchise agreements include a lease, a license and initial fees, as well as continuing rent and royalties to the company based upon a percent of sales with minimum rent payments. Under the agreement, franchisees are granted the right to operate a MCD’s restaurant under the company brand. In most cases, the lease of the restaurant facility lasts for a period of 20 years. At the end of the 20-year franchise agreement, MCD maintains control of the real estate and building and can either enter into a new 20-year agreement with the existing franchisee, a different franchisee, or close the restaurant.

In 2019, MCD received just over 64% of its franchised revenue from rent, 35% from royalties, and less than 1% from initial fees, as shown below.

Source: 10-K

Rent

Rent represents the largest revenue stream for franchised sales which accounts for 64% of franchised revenue and 37% of total revenue for the company. Rent revenue for the company come either as a base rent amount or is based on sales. The company states that 85% of MCD’s franchises pay rent to the company.

What makes MCD so unique compared to the company’s peers is that MCD covers all operating expenses related to the franchised stores, as well as the interest expense from the debt acquired to purchase the property, just through income made on rent from franchised stores. Due to this, MCD can almost be looked at as a REIT company, instead of a quick service restaurant.

Royalties

Royalties are MCD second largest revenue stream from franchised restaurants. Royalties accounted for 35% of franchised revenue and 19% of total company revenue.

Royalties for franchised restaurants are based on a percentage of sales. Estimates for royalty fees for a MCD franchise are in the range of 3-5% of sales. Royalties are based on a range depending on the profitability of the specific store.

Initial Fees

Initial fees represent less than 1% of franchise revenue. Initial fees consist of payments a franchisee must pay MCD in order to enter into a franchise contract. Initial fees are made each time a new franchise contract is signed with the company. The general length of a MCD franchise contract is 20 years. The estimated initial fee for a MCD contract is $45,000. It is assumed that MCD charges a low initial fee on franchise contracts in order to further incentivize new franchise agreements as the company makes the nearly all franchise revenue for rent and royalties.

Geographic Breakdown

McDonald’s operates worldwide but breaks down segments into two primary geographic operating segments which include the U.S. and International Markets. International markets include International operated markets as well as International Developmental Licensed Markets & Corporate. International markets represent McDonald’s largest segment of revenue on a geographic basis.

The following graph demonstrates the geographic revenue breakdown for MCD.

Source: Company 10K

In 2019, MCD received 37.2% of revenue from the U.S. domestic market and the remaining 62.8% from international markets. We have projected that MCD will continue growing internationally and believe that the

international market will comprise of 66.5% of MCD revenue in 2024.

U.S.

The U.S. market continues to be MCD’s more mature market. The company has a very significant footprint in the U.S. and is very well developed. The U.S. market accounted for 37.2% of total company revenue in 2019.

692 Company Operated / 13,153 Franchised

International

The international market continues to be MCD’s higher growth segment. In the past three years, the International market surpassed U.S. sales and become MCD largest geographic segment. The international market accounted for 62.8% of total revenue in 2019.

1,962 Company Operated / 22,887 Franchised

Cost Structure Analysis

The following graphs shows MCD TTM gross, operating and net margins from the last five years. As you can see, leading up to the second half of 2019, MCD had been steadily increasing all margins across the board. Notably, MCD had increased gross margins from around 37% in 2015 to around 53% mid-way through 2019. MCD was also able to increase their net margin from 16% in 2015 to above 28% in 2019.

Historical Margins

Source: Macrotrends

The graph below shows our projection for operating margins in the forecast period. We believe that MCD will be able to see significant expansion in their operating margin over the next five years. We believe that MCD has made significant investments in technology with the goal of increasing margins. We do not believe that the effects of these investments have fully paid off and why we believe MCD will be able to continue growing their operating margin.

Source: Company 10K

We also believe that margins will continue to increase due to the fact the company is continuing to flip company operated store to franchised. We forecast that operating margins will gradually improve each of the next five years and will reach 48.3% in 2024. Both of these will help drive MCD’s margin expansion across the board.

ESG Analysis

McDonald’s is currently rated as a BB on MSCI ESG rating scale. The scale is based on the same that of a bond rating scale. McDonald’s ESG rating has remain unchanged since June 2017 even though the company has increased focus on ESG as a whole. The following demonstrates how MCD compares to industry peers on an ESG basis.

Source: MSCI

RECENT DEVELOPMENTS

Q2 Earnings Announcement (Ended June 30)

• EPS of $0.65 Vs. $0.74 expected • Revenue of $3.77 billion vs $3.68 billion expected

Q2 Financial & Operational Performance Highlights

• As of June 30, 2020, nearly all MCD’s restaurants were open globally

• Global comparable sales decreased 23.9% for Q2 • Consolidated revenues decreased 30% • Systemwide sales decreased 24%

Source: Company 10K

As seen above, although MCD posted comparable sales growth of -23.9% for Q2 2020, we can see on a per month basis that comparable sales growth dramatically improved each sequential month.

U.S.

Comparable sales in the U.S. saw the strongest recovery with comparable sales reaching only -2.3% on the final month of Q2. The U.S. segment continued to benefit from strong average check growth. This can be attributed to the increase in delivery orders placed as the COVID-19 pandemic continues and consumer have been placing more online orders. However, comparable sales were still negative largely due to the significant negative comparable guest count growth.

International Markets

Source: Company 10K

As of end of Q2, 96% of MCD restaurants were open and operating on some sort of scale. This includes restaurants operating drive-thru, delivery, and/or take-away with a

limited menu as well as some limited hours. There were about 2,000 restaurant dining rooms open with limited capacity and seating.

COVID-19 Impact

Like any business, COVID-19 took a significant toll on MCD, as discussed above. The global pandemic forced the chain to temporary close restaurants and significantly impacted sales. However, the company has taken important steps in order to maintain financial flexibility including temporarily suspending their share repurchase program, increasing cash position by raising additional debt, as well as reducing capital expenditure for the year as a result of opening fewer restaurants.

INDUSTRY TRENDS

In the past decade, the fast-food restaurant industry has been forced to adapt to changing consumer preferences and a highly competitive market which have kept prices low. The industry has been under increased internal and external competition which has forced industry players to lower prices in order to compete and draw in customers. COVID-19 put immense pressure on the industry from falling consumer sentiment due to the shelter-in-place order put on most states during Q2 2020. The outbreak led to a significant decreased in industry demand, which saw industry revenue decline by around 16% as of Q2 2020. As a result, industry revenue has declined at an annualized rate of 0.4% to $239 billion over the past 5 years leading up to 2020. We expect that industry competition will remain high over the forecast period and will keep increasing price pressure. The industry as a whole is expected to increase at an annualized rate of 3.4% over the next five years and reach $281.9 billion in 2025.

Healthy Options

Demand for healthier option has not only spread across the fast-food industry, but also across all things related to food and drink. Consumer have become increasingly more health conscious which has forced the industry to adapt products and add new healthier items to attract customers. Although MCD target market is convenience and low-cost food, the emergence of new fast food restaurants that focus more on healthy option, like Chipotle, pose the biggest threats to MCD within the industry.

The fast food industry runs on very thin margins as the prices on products are usually very low compared to that of gourmet, fresher food options. The issue for companies in the QSR industry is that the cost of purchasing healthier options like vegan burgers is significantly higher than the cost of the current products MCD uses. However, MCD must continue offering more healthy option if the company wants to continue growing in line with the industry. We expect that MCD will continue adding to their menu and offering “healthy” options either as new products, or healthier variations of existing products. It is important to note that this can be beneficial for MCD. These “healthy” options allow the firm to mark-up prices which have higher margins on these products.

New Products

The fast-food industry is in the mature stage of its life cycle, especially in the U.S. where the market is extremely saturated. As a result, most competitors sell very similar products and product differentiation is hard and that is why price is a key for companies to attract consumers. However, companies must also compete through offering new products and adapting to consumers changing demands. MCD has made many changes and its menu is definitely one of them. To the day, MCD continues to expand different products in hopes of increasing sales.

Breakfast

Overall, the fast food service restaurant industry is currently in a very slow-growth stage. However, there has been an increasing demand for breakfast products as shown below.

Source: Statistica

Recently, there has been fierce competition among industry players to capitalize on this consumer trend. In 2015, MCD started offering all-day breakfast to capitalize on this trend attempting to increase same store sales. The concept helped MCD further expand their menu, however, selling these additional items all day comes with additional costs.

In 2019, the company decided to decrease their breakfast offerings. The company announced that breakfast menu items after normal breakfast hours, will be decided by the individual franchisees. However, MCD breakfast menu has a clear advantage over many of its competitors that offer a very limited menu, or do not have breakfast options at all.

Plant-Based Meat

Plant-based meats continue to disrupt the meat industry and have also become a large topic of opportunity within the fast food restaurant industry. The question is, do plant-based meats offer an opportunity for MCD or do they pose a threat? Multiple fast-food restaurants have started or tried adding plant-based meats to their menu in hopes of expanding into the vegan and vegetarian consumer base, including MCD.

In September of 2019, MCD announced it would start testing a new “plant, lettuce, tomato” also known as a P.L.T. to their menu which used Beyond Meat’s patties. However, in the middle of 2020, the company decided to pull back on plant-based meats and ended its trial in the Canadian market. The company says it will wait and see before trying to add the option back to its menu in the future and currently has no plans regarding plant-based meat in their menu.

The issue for companies in the fast food restaurant industry regarding plant-based meat is that they significantly impact margins. To start, we have to consider that plant-based meat products must be prepared separately from regular meat options. Secondly, plant-based patties cost nearly $2.9, while regular beef patties cost only $0.80. This causes prices to be significantly higher for plant-based meat options.

Technology

Technological advancements have allowed fast food restaurants to increase sales and offer an addition revenue channel through mobile/online orders. In the last five

years, food delivery has increased significantly as more people have the ability to get food delivered straight to their door. Technological advances have also become a focal point for allowing companies to automate process and reduce employee headcount. This has become extremely important in recent years due to the increased pressure on minimum wage. MCD has been able to capitalize on their technological investments by acquiring and partnering with artificial intelligence and machine learning companies which have allowed the company to further automate process in drive-thru and in-person ordering kiosks which have all allowed the firm cut on cuts and speed wait times. We believe that COVID-19 has only helped the company in regard to their technological advancements as the pandemic has helped speed up the need and desire for contactless purchases, either through online orders, or drive-thru.

MARKETS AND COMPETITION

Within the quick service restaurant (QSR) industry, MCD is the clear market leader by pure size. MCD has a market capitalization of around $164 billion making it the clear leader in the industry. Some of MCD main competitors within the QSR include Wendy’s, Chipotle, Restaurant Brands Intnl., Yum! Brands, Jack in The Box, and Starbucks.

Franchise Vs. Company Operated Mix

Within the QSR industry, companies can either operate company operated stores, which the company has full control over, or franchised stores which the company receives a certain percentage of the stores revenue. It is important to understand the store ownership mix in order to properly compare MCD to its competitors. As mentioned, company operated stores produce significantly higher revenues, as the company receives all of the income from the store. Franchised stores on the other hand, have significantly lower sales, but have much higher margins. The following graph demonstrates the store ownership mix of MCD and some of its competitors.

Source: Company 10K

As we can see, many companies within the industry have a higher percentage of franchised stores. We believe that this is due to the fact that the industry is in the mature stage of its life cycle. As revenue growth slows, companies begin focusing on improving margins to increase their valuations and the franchise store model does just that.

Margins

The following table shows the gross, EBIT, and net margin of MCD and some of the firms’ competitors. On a margin basis, we can see MCD is the clear leader. Not only does MCD have the highest gross margin, but also the highest EBIT and net margins within the industry.

Source: Company 10K

As discussed earlier, the benefit of a franchised restaurant model is clearly evident. On a margin basis, we can see that the two companies that do not franchise store, SBUX and CMG, have significantly lower margins across the board of competitors. As for gross margins, QSR has higher margins than MCD, while YUM is just below. It is important to note that these two companies are the best comparable to MCD on a store ownership mix of Franchised vs. company operated as QSR is 100% franchised and YUM has 98.2% franchised stores. It is clearly evident that companies who franchise a higher percentage of stores, usually have higher margins.

On an EBIT and net margin basis, no other competitor has higher margins. This is due to the fact that MCD owns the majority of their own real estate, they do not have to pay rent expenses. Recently, this has also been a large benefit for MCD as real estate prices and the national average rent have both been increasing in recent years, reaching record highs. In 2019, the national average rent increased by 3.3% YoY. MCD has also made significant technological investments, well ahead of its peers, in order to further automate the process of ordering, reduce employee head count, and decrease wait time which in turn has helped MCD reduce SG&A expense. We believe that these technological investments still haven’t demonstrated their true value yet and believe MCD will be able to continue expanding margins in the forecast period.

Same Store Sales Growth

Same store sales growth is one of the most important financial metrics within the QSR industry. In the early stages of business cycle, firms try and drive growth through opening more stores. However, this becomes an issue when there are simply too many stores, and restaurants begin cannibalizing sales. Same store sales on the other hand, measures the amount of revenue percentage increase of a chain’s existing location given the time period from the previous year. In other words, it measures how well the company is driving sales growth without opening new stores. The following graph demonstrates the same store sales growth of MCD and its peers for 2019.

Source: FactSet

CMG is the clear leader of SSS in the industry which is nearly double that of MCD which is second on the list at 5.9%. SBUX is another noted competitor and comes in just behind MCD at 5% SSS in 2019. All of MCD’s other competitors fall from 3.4% to 1.3% SSS growth. The

question is, what is driving this higher performance of SSS from CMG and SBUX? It is the technological advancements and investments that these companies have made in order to grow same store sales. Both of these companies have industry leading online platforms in order to purchase meals online, get delivery, as well as earn reward points. We believe these companies have been able to significantly grow SSS through these online platforms. Not only do we believe having mobile orders increase the amount consumer purchase from the company, but also mobile orders have been estimates to be 2-3x the price of in-person orders.

Current Market Analysis

We know that MCD is already the leader in the industry based on its massive size. However, we wanted to analyze MCD and its peers based on key financial ratios within the industry.

Source: FactSet

As seen above, on an EV/EBITDA basis, MCD is currently trading at 18.6x which is slightly below the industry average we calculated of 19.5x. On an EV/Sales basis, MCD is trading significantly above the industry average of 5.6x. As for FCF yield, MCD is exactly in line with the industry average of 3.8%.

As for Net Debt/EBITDA, MCD currently has a ratio of 4.5x net debt to EBITDA which is slightly above the industry average of 4.3x. This is expected considering the fact that MCD has a significant amount of real estate which it has taken out debt to acquire.

Source: FactSet

As for relative valuation metrics, we can see that MCD currently trades at the very top of the list on a Price to Sales basis at nearly 3x above the industry average. On the contrary, however, MCD trades near the very bottom in the industry on a Price to Earnings basis. It is very interesting to note how MCD trades on the opposite side of the spectrum in the industry based on these two different relative valuation metrics. On a pure sales basis, MCD is currently valued much higher than the industry. On an earnings basis, the market believes that the price does not justify the company’s earnings compared to other industry players.

We can conclude from the EV/EBITDA and the Price/Earnings ratios that MCD is currently undervalued in market compared to its competitors. On both of these metrics we can see that Chipotle is the clear industry leader with significantly higher ratios on both metrics. This is due to the fact that CMG is a growth company, unlike MCD which is well into its mature phase. At this stage, MCD is not focusing on increasing revenues, but rather expanding margins. CMG on the other hand, still has plenty of room to grow as a much newer company. We believe this is why CMG is valued much higher than any other peer’s which have significantly lower future growth expectations.

ECONOMIC OUTLOOK

Real Gross Domestic Product (GDP)

Positive economic growth will continue to drive consumer spending in the global economy as well as the consumer sector. Real GDP is the most important indicator of the U.S. economy by providing a holistic view of the health of the

economy, taking into account inflation and deflation. Personal consumption expenditures account for 68% of the share of GDP.

As a retail company, MCD’s revenue is almost entirely driven by consumer spending and positive economic growth. The US economy grew by 2.3% in 2019 which was driven by consumer consumption and business investment. With the current state of the Corona virus, we expect slower global growth in the coming years. As seen below, Q1 2020 GDP was -5% and Q2 2020 GDP was negative 31.7%.

Source: U.S. Bureau of Economic Analysis

We expect growth to take hit this year due to worldwide shutdowns seen in the first two quarters of 2020. We estimate that Q3 GDP will rise around 20% and for the year ended 2020, GDP will be around -5%. We expect the U.S. to remain in a lower growth environment for the next year as the country continues to suffer from COVID-19. We expect the U.S. economy to return back to rates around the 2% level in 2022. We estimate growth to stay steady around this level for the following years, before increasing slightly to the most recent five-year GDP average of 2.3% in the long run.

Consumer Confidence

The Consumer Confidence Index (CCI) is a predictive indicator of consumer spending and also measures the optimism of citizens in the United States. As mentioned, having a strong consumer is imperative for a company like MCD making consumer confidence a key economic indicator to examine. The consumer confidence index decreased in August after decreasing in July as well. The index is currently at 84.8, down from the 91.7 seen in July. The Present Situation Index decreased sharply as consumers stated both business and employment activity had deteriorated from July to August. Although consumer

spending has rebounded in recent months, increasing concerns about the economic outlook amongst consumers is predicted to slow spending in the coming months. However, we do predict that consumer confidence will begin to increase in the short-term as the world begins to find more answers to COVID-19 and a possible vaccination. We believe that consumer confidence will be positive in a year’s time and the CCI will return to normal levels.

Unemployment Rate

The Unemployment Rate is another overall indicator of the health of the economy. Though, it is more of a lagging indicator than a leading one. Low unemployment tends to lead to increased disposable income and a positive effect on consumer spending and confidence. Low levels of unemployment and increased disposable income are reflected in the high consumer confidence levels currently seen in the US economy. 2019 was a strong year for job growth which saw the unemployment rate drop to 3.6%. The unemployment rate has showed steady declines over the last six years. These low levels of unemployment can be directly correlated with the strong consumer confidence we have seen. Specifically, low unemployment levels lead to increased consumer spending. We see this as something that has benefited MCD sales. Recently, the Jobless claim numbers have spiked to record numbers due to COVID-19 as seen below.

Source: BLS

In August, the unemployment rate declined by 1.8% to 8.4% and the total number of unemployed persons fell by 2. Million to 13.6 million. In the past 4 months, both measures have declined but are still significantly higher

than seen in February before the effects of COVID-19. We expect that the unemployment rate will continue to decrease as concerns of COVID-19 fade away. We expect that unemployment level will return to around 4-5% within the next year before leveling off around 4% in 2 years.

Interest Rates

The Fed Funds Rate currently stands at 0.25%. As seen in the graph below, starting in the second half of 2019, the FED has significantly cut rates in the LTM. The Fed Funds rate was 2.5% in the start of 2019.

FED Funds Rate

Source: FED

The FED had to cut rates as the economy suffered and the market outlook was very gloomy due to COVID-19. Cutting rates helps project economic growth as it allows firms to borrow capital at a cheaper cost and also used to encourages increased consumer spending. Due to the fact that MCD has a significant amount of debt, as well as debt on the company’s leases, lower interest rates benefit MCD significantly. With lower rates, MCD will be able to refinance existing debt and lower interest expense.

VALUATION

Revenue

We have forecasted revenue right in line with analyst consensus in our forecast period at a CAGR of around 1.98%. We have forecasted a CV growth rate of 1.9%. We believe that the company’s growth will stay very stagnant over the forecast period and believe MCD is already operating near their steady state.

We differ from analysts on company operated revenue. We have project company operated store revenue to be lower than consensus. The company has stated that their main focus is to reach 95% franchised stores. We believe that the company will be able to achieve this by 2024. Due to this, we believe that seeing growth in this segment will not happen as the company continues to strip company operated stores. For this reason, we have projected company operated store revenue to be lower than consensus. Our franchised store revenue forecasts are slightly above analyst’s consensus. We believe that MCD will start flipping franchise restaurants quicker than others believe. We believe that COVID-19 will accelerate the company’s plan on reaching 95% franchised stores as the economic outlook is still gloomy.

Margins

We differ from consensus slightly on a margin’s basis. We have forecasted margins to increase at a slightly faster rate than other analysts. We believe that MCD main focus is now on margins. The company realizes that there is little room for growth in the company’s life cycle, thus that have implemented significant measures in order in improve margins. This is seen through the company’s technological investments focused on improving efficiency, automating processes, and decreasing employee head count. We believe that the industry will continue to become more technological focused and will greatly benefit MCD on a margins basis.

As stated earlier, we also believe that MCD will be shifting to a 95% franchised model quicker than others expect. By doing this, MCD will be able to continue improving margins as the company eliminates the significant costs associated with company operated restaurants.

Valuation

Discounted Cash Flow (DCF) - $256

For our DCF we analyzed each of MCD’s operating segments as discussed earlier to determine our growth forecasts. We have put the most emphasis on our DCF model, as we believe the DCF most accurately captures MCD intrinsic value due to the fact that we were able to construct varying operating scenarios and capture a range of different variables that affect MCD share price. While

we believe the DCF is the best representation of the target price. Our discounted cash flow and economic profit analysis calculated our target price of $260 using the various assumptions discussed earlier. The assumptions used reflected our overall opinions on the economy, industry, and MCD itself. By forecasting performance for each of the MCD’s business segments, we believe we have captured the most accurate value with the discounted cash flow analysis. The current average consensus target price from MCD is around $230.

Weighted Average Cost of Capital

We calculated a WACC of 4.62%, which we kept constant through the forecast period. We have also assumed that the company keeps a consistent capital structure. Currently, the company has around 22% debt in their capital structure and has remained relatively stable in the past around 20%.

Cost of Debt

We calculated an after-tax cost of debt of 1.82%. We used a pre-tax cost of debt of 2.41% which was the YTM on a current 15-year MCD bond. We used a marginal tax rate of 24%. The current risk-free rate on a 10-year US Treasury is 0.67%. This implied a default premium of 1.74% on MCD’s debt.

Cost of Equity

We calculated a cost of equity of 5.41% using the CAPM equation. We used an Equity Risk Premium of 5.15% which was the consensus Henry Fund estimate. We calculated the cost of equity this using the historical 3-year adjusted beta of .92 and a risk-free rate of 0.67%.

Relative Valuation - $260

Using the relative valuation model, we pulled comparable peer companies in order to value MCD relative to how other industry players are currently valued. The companies we used included Wendy’s, Chipotle, Restaurant Brands International., Yum! Brands, and Jack in the Box. Due to MCD’s pure size, there are not many companies that truly compare with MCD. Instead, we focused rather on products, geography, and restaurant type. We removed outliers from our peer comparison to better capture the

true relative value of MCD. Ultimately, we decided that the 2021E Price/Earnings best captures the true relative value of MCD. We believe that 2020 numbers are still going to be impacted by COVID-19 and thus, are less accurate representation.

On both a 2020E and 2021E P/E multiple, MCD currently trades well below the industry average. We arrived at a 2021E P/E value of $259.7. This is almost identical to the value derived using the DCF model.

Dividend Discount Model (DDM) - $273

Using the DDM we arrived at a target price of $271. Although this is very close to the intrinsic value calculated using our other models, we believe that the DDM does not provide an accurate representation to value MCD. Although MCD has continued to pay dividends, the dividend growth has been inconsistent. In the past 5 years, MCD has seen dividend per share growth of 4.8% to 12.9% seen in 2019.

Valuation Summary

After analysis, the Henry Fund believes that MCD is currently trading below its intrinsic value. We believe that MCD should be trading in the $240-260 price range, which represents an upside of 10-20%.

Currently, MCD is trading at around $219 per share. We believe that our target range of $240-260 is right in line with consensus. Thus, if the price of MCD is to reach $240, we would consider selling some shares and rebalancing our weight of Amazon in the portfolio.

CATALYSTS AND KEYS TO MONITOR

Going forward it is crucial to further monitor MCD technological investments. We believe that it will be critical for the company’s success to continue being a leader in technology among its competitors. Margin expansion projections stem largely from the belief that the company will be able to continue automating process going forward. We believe that MCD is best positioned within the industry to offer the first automated drive thru. We believe this will be the next large industry trend and believe MCD is best position to capitalize.

Same store sales will continue to be a large driver of our model. With the company already becoming saturated, we have projected new store growth to be relatively slow. Thus, MCD will have to continue growing sales thru SSS growth. Currently, MCD is an industry leader and we have projected them to continue having this strong growth. If MCD were to start lagging competitors in SSS this would signal a sell rating.

Currently, MCD is trading at around $219 per share. We believe that our target range of $240-260 is slightly more bullish compared to consensus. Thus, if the price of MCD is to reach $240, we would consider selling some shares and rebalancing our weight of MCD in the portfolio.

REFERENCES

1. https://www.bls.gov/news.release/pdf/empsit.pdf 2. https://conference-

board.org/data/consumerconfidence.cfm 3. https://corporate.mcdonalds.com/content/dam/gwsc

orp/nfl/investor-relations-content/annual-reports/2019%20Annual%20Report.pdf

4. https://www.macrotrends.net/stocks/charts/MCD/mcdonalds/profit-margins

5. https://www.rentcafe.com/blog/category/rental-market/apartment-rent-report/

6. https://www.forbes.com/sites/dimawilliams/2020/07/10/is-it-going-to-get-better-before-it-gets-worse-five-experts-share-predictions-for-the-us-housing-market-in-the-second-half-of-2020/#2f55405a7026

7. https://www.nbcnews.com/business/business-news/mcdonald-s-introduces-beyond-meat-p-l-t-their-menu-n1058961

8. https://my-ibisworld-com.proxy.lib.uiowa.edu/us/en/industry/72221a/industry-performance#key-external-drivers

9. https://www.cnbc.com/2020/07/28/mcdonalds-mcd-q2-2020-earnings.html

10. https://blog.wallstreetsurvivor.com/2015/10/08/mcdonalds-beyond-the-burger/

11. https://www.msci.com/esg-ratings/issuer/mcdonald-s-corporation/IID000000002148687

12. https://my.apps.factset.com/navigator/company-security/MCD

13. Bloomberg 14. https://corporate.mcdonalds.com/corpmcd/scale

-for-good/esg-reporting/progress-and-performance.html

DISCLAIMER

Henry Fund reports are created by graduate students in the Applied Securities Management program at the University of Iowa’s Tippie College of Business. These reports provide potential employers and other interested parties an example of the analytical skills, investment knowledge, and communication abilities of our students. Henry Fund analysts are not registered investment advisors, brokers or licensed financial professionals. The investment opinion contained in this report does not represent an offer or solicitation to buy or sell any of the aforementioned securities. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Henry Fund may hold an investment position in the companies mentioned in this report.

McDonald'sRevenue Decomposition

Fiscal Years Ending Dec. 31 2017 2018 2019 2020E 2021E 2022E 2023E 2024E

Company-operated Sales U.S. $ 3,260 $ 2,665 $ 2,490 $ 2,241 $ 2,196 $ 1,977 $ 1,818 $ 1,709

Growth -12.9% -18.3% -6.6% -10.0% -2.0% -10.0% -8.0% -6.0%% of Total Revenue 14.3% 12.7% 11.8% 11.8% 10.7% 9.3% 8.2% 7.4%

# of restaurants 842 696 692 609 542 488 444 408 Growth -25.6% -17.3% -0.6% -12.0% -11.0% -10.0% -9.0% -8.0%

Revenue per restaurant $ 3.87 $ 3.83 $ 3.60 $ 3.68 $ 4.05 $ 4.05 $ 4.10 $ 4.19

International 9,459$ 7,348$ 6,931$ 6,099$ 6,831$ 7,036$ 7,212$ 7,356$ Growth 18.1% -22.3% -5.7% -12.0% 12.0% 3.0% 2.5% 2.0%% of Total Revenue 41.5% 34.9% 32.9% 32.1% 33.3% 32.9% 32.4% 31.8%

# of restaurants 2,226 2,123 1,962 1,903 1,846 1,809 1,773 1,737 Growth -4.6% -7.6% -3.0% -3.0% -2.0% -2.0% -2.0%

Revenue per restaurant 4.25$ 3.46$ 3.53$ 3.20$ 3.70$ 3.89$ 4.07$ 4.23$

Total Company Operated Sales 12,719$ 10,013$ 9,421$ 8,340$ 9,027$ 9,013$ 9,030$ 9,066$ % of Total Revenue 55.7% 47.6% 44.7% 44.0% 44.0% 42.2% 40.6% 39.2%

Franchised SalesU.S. 4,746$ 5,001$ 5,353$ 5,085$ 5,354$ 5,604$ 5,833$ 6,036$

Growth 5.2% 5.4% 7.0% -5.0% 5.3% 4.7% 4.1% 3.5%% of Total Revenue 20.8% 23.8% 25.4% 26.8% 26.1% 26.2% 26.2% 26.1%

# of restaurants 13,194 13,218 13,153 13,192 13,232 13,272 13,312 13,351 Growth 1.3% 0.2% -0.5% 0.3% 0.3% 0.3% 0.3% 0.3%


International 5,355$ 6,011$ 6,303$ 5,547$ 6,129$ 6,742$ 7,382$ 8,047$ Growth 11.2% 12.3% 4.9% -12.0% 10.5% 10.0% 9.5% 9.0%% of Total Revenue 23.5% 28.6% 29.9% 29.2% 29.9% 31.6% 33.2% 34.8%

# of restaurants 20,979 21,818 22,887 24,031 24,993 25,742 26,257 26,782 Growth 15.6% 4.0% 4.9% 5.0% 4.0% 3.0% 2.0% 2.0%


Total Franchise Sales 10,101$ 11,012$ 11,656$ 10,632$ 11,483$ 12,346$ 13,216$ 14,083$ % of Total Revenue 44.3% 52.4% 55.3% 56.0% 56.0% 57.8% 59.4% 60.8%

Systemwide RevenuesU.S. 8,006$ 7,666$ 7,843$ 7,326$ 7,550$ 7,581$ 7,652$ 7,746$

Growth -4.25% 2.31% -6.59% 3.05% 0.41% 0.93% 1.23%% of Total Revenue 35.1% 36.5% 37.2% 38.6% 36.8% 35.5% 34.4% 33.5%

# of Restraunts 14,036 13,914 13,845 13,801 13,774 13,760 13,755 13,760 % of total stores 38% 37% 36% 35% 34% 33% 33% 33%

International 14,814$ 13,359$ 13,234$ 11,646$ 12,960$ 13,778$ 14,594$ 15,403$ % of Total Revenue 64.9% 63.5% 62.8% 61.4% 63.2% 64.5% 65.6% 66.5%# of Restraunts 23,205 23,941 24,849 25,934 26,839 27,552 28,030 28,520 % of total stores 62% 63% 64% 65% 66% 67% 67% 67%

Total Revenues 22,820$ 21,025$ 21,077$ 18,972$ 20,510$ 21,359$ 22,246$ 23,149$ # of Restraunts 37,241 37,855 38,694 39,736 40,613 41,311 41,786 42,280

McDonald'sIncome Statement


Company-operated store Sales 12,719 10,013 9,421 8,340 9,027 9,013 9,030 9,066 Franchised stores sales 10,102 11,013 11,656 10,632 11,483 12,346 13,216 14,083

Total revenues 22,821 21,026 21,077 18,972 20,510 21,359 22,246 23,149

Food & paper expense 4,034 3,154 2,980 2,550 2,675 2,700 2,723 2,741 Payroll & employee benefits expense 3,529 2,938 2,704 2,302 2,427 2,484 2,543 2,600 Ocupancy & other operating expenses 2,848 2,174 2,076 1,831 1,959 2,018 2,080 2,141 Franchised restraunts - occupancy expenses 1,790 1,973 2,201 2,007 2,169 2,333 2,499 2,665 SG&A expense 2,231 2,200 2,229 1,900 1,972 1,990 2,006 2,064

Other operating expense (1,163) (237) (184) (190) (205) (214) (222) (231) Total operating costs & expenses 13,269 12,202 12,007 10,400 10,996 11,312 11,628 11,979

EBIT (Operating income) 9,552 8,824 9,070 8,572 9,514 10,047 10,618 11,170

Interest expense 921 981 1,122 1,146 1,237 1,315 1,347 1,458 Non-operating expense 58 25 (70) 38 41 43 44 46 Income before provision for income taxes 8,573 7,818 8,018 7,388 8,236 8,690 9,226 9,665

Provision for income taxes 3,381 1,892 1,993 1,795 2,001 2,112 2,242 2,349 Net income 5,192 5,926 6,025 5,593 6,235 6,578 6,984 7,316

Common Shares Outstanding 794 767 746 739 732 724 715 707WASO 807 781 757 743 735 728 720 711Net income per basic share 6.43 7.59 7.96 7.53 8.48 9.04 9.70 10.29Dividends declared per common share 3.83 4.19 4.73 4.21 6.23 6.91 7.33 8.05

McDonald'sBalance Sheet

Fiscal Years Ending Dec. 31 2017 2018 2019 2020E 2021E 2022E 2023E 2024EAssets

Cash & equivalents 2,464 866 899 4,210 7,887 9,903 15,313 13,871 Accounts & notes recievable 1,976 2,442 2,224 1,897 2,154 2,350 2,558 2,778 Inventories 59 51 50 52 54 54 54 54 Prepaid expenses & other current assets 828 695 385 738 798 831 866 901

Total current assests 5,327 4,053 3,558 6,898 10,892 13,138 18,791 17,604 PP&E, gross 36,626 37,194 39,051 41,451 43,851 46,251 48,651 51,051

Acc. Depr. (14,178) (14,351) (14,891) (16,673) (18,617) (20,742) (22,971) (25,427)Net PP&E 22,448 22,843 24,160 24,778 25,234 25,509 25,680 25,624 Lease right-of-use asset, net - - 13,261 13,618 13,919 14,158 14,321 14,490

Total PP&E, net 22,448 22,843 37,421 38,397 39,152 39,668 40,001 40,114 Investments in and advances to affiliates 1,253 1,207 1,471 1,559 1,653 1,752 1,857 1,969 Goodwill 2,380 2,332 2,677 2,677 2,677 2,677 2,677 2,677 Deferred Tax Assets 868 1,219 1,139 1,082 1,028 977 928 881 Miscellaneous 1,528 1,158 1,244 1,244 1,244 1,244 1,244 1,244

Total other assets 6,029 5,916 6,531 6,563 6,602 6,650 6,706 6,771 Total assets 33,804 32,811 47,511 51,857 56,647 59,456 65,498 64,489

LiabilitesST Debt & Curr. Portion of LT Dabt - - 680 59 2,132 2,250 6,007 2,819 Accounts payable 925 1,208 988 797 892 984 1,050 1,045 Income taxes payable 266 228 332 203 226 238 253 265 Accrued Payroll 1,146 987 1,026 920 995 1,036 1,079 1,123 Other Misc. Current Liabilities 554 551 595 595 595 595 595 595

Total current liabilites 2,891 2,974 3,621 2,574 4,840 5,103 8,984 5,847 Long-term debt 29,536 31,075 46,876 51,273 52,412 53,637 54,508 55,204 Defferred Tax Liability 1,119 1,216 1,318 1,252 1,190 1,130 1,074 1,020 Deferred revenues - initial franchise fees - 628 661 667 674 681 687 694 Other long-term liabilites 3,525 3,178 3,246 3,246 3,246 3,246 3,246 3,246

Total liabilities 37,071 39,070 55,721 59,012 62,361 63,797 68,499 66,011

Stockholders equityCommon stock &APIC 7,089 7,393 7,671 8,128 8,590 8,905 9,061 9,221 Retained earnings 48,326 50,487 52,931 55,523 58,558 61,736 65,120 68,637 Acc. Other comprehensive income (2,178) (2,610) (2,483) (2,483) (2,483) (2,483) (2,483) (2,483) Treasury Stock (56,504) (61,529) (66,329) (68,529) (70,729) (72,929) (75,129) (77,329)

Total shareholders equity (3,268) (6,258) (8,210) (7,360) (6,063) (4,770) (3,430) (1,954) Total liabilities & shareholders equity 33,804 32,812 47,511 51,857 56,647 59,455 65,498 64,489

McDonald'sForecasted Cash Flow Statement

Fiscal Years Ending Dec. 31 2020E 2021E 2022E 2023E 2024E

Cash Flows From Operating ActivitiesNet income 5,593 6,235 6,578 6,984 7,316

Depr. & Amort. Expense 1,782 1,945 2,124 2,230 2,456 Deferred Taxes Asset 57 54 51 49 46 Deferred Tax Liability (66) (63) (59) (57) (54)

Accounts & notes recievable 327 (256) (196) (209) (220)Inventories (2) (2) (0) (0) 0 PPE & other current assets (353) (60) (33) (35) (35)Accounts payable (191) 96 92 66 (5) Income taxes payable (129) 23 12 15 12 Accrued Payroll (106) 75 41 43 44 Deferred Revenue 7 7 7 7 7

Cash Flows From Operating Activities 6,911 8,046 8,610 9,086 9,562

Cash Flows From Investing activitiesInvestments in & andvances to affiliates (88) (94) (99) (105) (111) CapEx (2,400) (2,400) (2,400) (2,400) (2,400)

Cash Flows From Investing activities (2,488) (2,494) (2,499) (2,505) (2,511)

Cash Flows From Financing ActivitiesCurrent maturities of long-term debt (621) 2,073 118 3,757 (3,188) Long-term debt 4,397 1,138 1,225 871 696 Common stock & APIC 313 313 163 - - Common stock in treasury (2,200) (2,200) (2,200) (2,200) (2,200) Dividends paid (3,000) (3,200) (3,400) (3,600) (3,800)

Cash Flows From Financing Activities (1,111) (1,876) (4,094) (1,172) (8,492)

Increase (Decrease) in cash & equivalents 3,312 3,676 2,017 5,409 (1,442) Cash & equivilants at beg. Of year 899 4,210 7,887 9,903 15,313 Cash & equivilants at End Of year 4,210 7,887 9,903 15,313 13,871

McDonald'sHistorical Cash Flow Statement

Fiscal Years Ending Dec. 31 2015 2016 2017 2018 2019

Cash Flows From Operating ActivitiesNet income 4,529 4,687 5,192 5,924 6,025

Depr. & Amort. Expense 1,556 1,517 1,363 1,482 1,618 Deferred income taxes (1) (539) (36) 103 150 Share-based compensation 110 131 118 125 110 Net gain on sale of restraurant business (164) (311) (1,156) (309) (128) Other net income adjustments 342 408 1,051 114 49 Accounts recievable (181) (159) (341) (479) 27 Inventories 45 28 37 (2) 129 Accounts payable (15) 90 (60) 129 (27) Income taxes (64) 170 (396) (33) 173 Other accrued liabilities 383 38 (146) (87) (4)

Cash Flows From Operating Activities 6,539 6,060 5,626 6,967 8,122

Cash Flows From Investing activitiesCapEx (1,814) (1,821) (1,854) (2,742) (2,394) Purchase of restaurant business (141) (110) (77) (102) (541) Proceeds from sale of business in China & Hong Kong - - 1,597 - - Sales of property 213 83 167 160 151 Sales of restaurant business & property 341 976 975 531 341 Other investing activities (20) (110) (246) (303) (629)

Cash Flows from investing activities (1,420) (982) 562 (2,455) (3,071)

Cash Flows From Financing ActivitiesCurrent maturities of long-term debt 590 (286) (1,050) 96 799 Long-term financing issuances 10,220 3,780 4,728 3,795 4,499 Long-term financing repayments (1,055) (823) (1,649) (1,760) (2,062) Treasury stock purchases (6,099) (11,171) (4,686) (5,208) (4,976) Common stock dividends (3,230) (3,058) (3,089) (3,256) (3,582) Proceeds from stock option exercises 317 299 457 403 351 Excess tax benefit on share-based compensation 51 - - - - Other financing activites (59) (3) (21) (20) (24)

Cash Flows From Financing Activities 735 (11,262) (5,311) (5,950) (4,995)

Effect of exchange rates on cash & equivalents (247) (104) 264 (160) (24) Cash & equivalents increase (decrease) 5,608 (6,288) 1,141 (1,598) 32 Cash balance of business held for sale at end of year - (174) 174 - - Cash & equivalents at beg. Of year 2,078 7,686 1,223 2,538 941 Cash & equivalents at end of year 7,686 1,223 2,538 941 973 Interest paid 641 874 885 960 1,067 Income taxes paid 1,985 2,388 2,786 1,734 1,590

McDonald'sCommon Size Income Statement


Company-operated store Sales 55.7% 47.6% 44.7% 44.0% 44.0% 42.2% 40.6% 39.2%Franchised stores sales 44.3% 52.4% 55.3% 56.0% 56.0% 57.8% 59.4% 60.8%

Total revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Food & paper expense 17.7% 15.0% 14.1% 13.4% 13.0% 12.6% 12.2% 11.8%Payroll & employee benefits expense 15.5% 14.0% 12.8% 12.1% 11.8% 11.6% 11.4% 11.2%Ocupancy & other operating expenses 12.5% 10.3% 9.8% 9.6% 9.5% 9.4% 9.3% 9.2%Franchised restraunts - occupancy expenses 7.8% 9.4% 10.4% 10.6% 10.6% 10.9% 11.2% 11.5%SG&A expense 9.8% 10.5% 10.6% 10.0% 9.6% 9.3% 9.0% 8.9%Other operating expense -5.1% -1.1% -0.9% -1.0% -1.0% -1.0% -1.0% -1.0%

Total operating costs & expenses 58.1% 58.0% 57.0% 54.8% 53.6% 53.0% 52.3% 51.7%0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

EBIT (Operating income) 41.9% 42.0% 43.0% 45.2% 46.4% 47.0% 47.7% 48.3%

Interest expense 4.0% 4.7% 5.3% 6.0% 6.0% 6.2% 6.1% 6.3%Non-operating expense 0.3% 0.1% -0.3% 0.2% 0.2% 0.2% 0.2% 0.2%

Income before provision for income taxes 37.6% 37.2% 38.0% 38.9% 40.2% 40.7% 41.5% 41.8%

Provision for income taxes 14.8% 9.0% 9.5% 9.5% 9.8% 9.9% 10.1% 10.1%Net income 22.8% 28.2% 28.6% 29.5% 30.4% 30.8% 31.4% 31.6%

McDonald'sCommon Size Balance Sheet


AssetsCash & equivalents 10.8% 4.1% 4.3% 22.2% 38.5% 46.4% 68.8% 59.9%Accounts & notes recievable 8.7% 11.6% 10.6% 10.0% 10.5% 11.0% 11.5% 12.0%Inventories 0.3% 0.2% 0.2% 0.3% 0.3% 0.3% 0.2% 0.2%Prepaid expenses & other current assets 3.6% 3.3% 1.8% 3.9% 3.9% 3.9% 3.9% 3.9%

Total current assests 23.3% 19.3% 16.9% 36.4% 53.1% 61.5% 84.5% 76.0%PP&E, gross 160.5% 176.9% 185.3% 218.5% 213.8% 216.5% 218.7% 220.5%Acc. Depr. -62.1% -68.3% -70.7% -87.9% -90.8% -97.1% -103.3% -109.8%Net PP&E 98.4% 108.6% 114.6% 130.6% 123.0% 119.4% 115.4% 110.7%Lease right-of-use asset, net 0.0% 0.0% 62.9% 71.8% 67.9% 66.3% 64.4% 62.6%Total PP&E, net 98.4% 108.6% 177.5% 202.4% 190.9% 185.7% 179.8% 173.3%Investments in and advances to affiliates 5.5% 5.7% 7.0% 8.2% 8.1% 8.2% 8.3% 8.5%Goodwill 10.4% 11.1% 12.7% 14.1% 13.1% 12.5% 12.0% 11.6%Deferred Tax Assets 3.8% 5.8% 5.4% 5.7% 5.0% 4.6% 4.2% 3.8%Miscellaneous 6.7% 5.5% 5.9% 6.6% 6.1% 5.8% 5.6% 5.4%

Total other assets 26.4% 28.1% 31.0% 34.6% 32.2% 31.1% 30.1% 29.3%Total assets 148.1% 156.1% 225.4% 273.3% 276.2% 278.4% 294.4% 278.6%

LiabilitesST Debt & Curr. Portion of LT Dabt 0.0% 0.0% 3.2% 0.3% 10.4% 10.5% 27.0% 12.2%Accounts payable 4.1% 5.7% 4.7% 4.2% 4.4% 4.6% 4.7% 4.5%Income taxes payable 1.2% 1.1% 1.6% 1.1% 1.1% 1.1% 1.1% 1.1%Accrued Payroll 5.0% 4.7% 4.9% 4.9% 4.9% 4.9% 4.9% 4.9%Other Misc. Current Liabilities 2.4% 2.6% 2.8% 3.1% 2.9% 2.8% 2.7% 2.6%

Total current liabilites 12.7% 14.1% 17.2% 13.6% 23.6% 23.9% 40.4% 25.3%Long-term debt 129.4% 147.8% 222.4% 270.3% 255.5% 251.1% 245.0% 238.5%Defferred Tax Liability 4.9% 5.8% 6.3% 6.6% 5.8% 5.3% 4.8% 4.4%Deferred revenues - initial franchise fees 0.0% 3.0% 3.1% 3.5% 3.3% 3.2% 3.1% 3.0%Other long-term liabilites 15.4% 15.1% 15.4% 17.1% 15.8% 15.2% 14.6% 14.0%

Total liabilities 162.4% 185.8% 264.4% 311.0% 304.0% 298.7% 307.9% 285.2%

Stockholders equityCommon stock &APIC 31.1% 35.2% 36.4% 42.8% 41.9% 41.7% 40.7% 39.8%Retained earnings 211.8% 240.1% 251.1% 292.7% 285.5% 289.0% 292.7% 296.5%Acc. Other comprehensive income -9.5% -12.4% -11.8% -13.1% -12.1% -11.6% -11.2% -10.7%Treasury Stock -247.6% -292.6% -314.7% -361.2% -344.8% -341.4% -337.7% -334.1%

Total shareholders equity -14.3% -29.8% -39.0% -38.8% -29.6% -22.3% -15.4% -8.4%Total liabilities & shareholders equity 148.1% 156.1% 225.4% 273.3% 276.2% 278.4% 294.4% 278.6%

McDonald'sValue Driver Estimation


Revenue 22,821 21,026 21,077 18,972 20,510 21,359 22,246 23,149 Less food & paper expense 4,034 3,154 2,980 2,550 2,675 2,700 2,723 2,741 Less payroll & employee benefits expense 3,529 2,938 2,704 2,302 2,427 2,484 2,543 2,600 Less occupancy & other operating expenses 2,848 2,174 2,076 1,831 1,959 2,018 2,080 2,141

Less franchise retaurants - occupancy expenses 1,790 1,973 2,201 2,007 2,169 2,333 2,499 2,665 Less SG&A 2,231 2,200 2,229 1,900 1,972 1,990 2,006 2,064 Plus implied interest on operating leases 244 251 368 383 398 414 431 448

EBITA 8,146 8,336 8,518 8,000 8,911 9,419 9,965 10,490 Income tax expense 3,381 1,892 1,993 1,795 2,001 2,112 2,242 2,349

Marginal tax rate 31.7% 39.4% 24.3% 24.3% 24.3% 24.3% 24.3% 24.3%Plus tax sheild on interest expense 292 387 273 279 301 319 327 354 Plus tax sheild on interest of operating leases 77 99 89 93 97 101 105 109

Less total adjusted tax 3,750 2,377 2,355 2,167 2,399 2,532 2,674 2,812 Plus change in deferred tax (255) 183 (9) (9) (8) (8) (7)NOPLAT 4,396 5,703 6,346 5,824 6,504 6,879 7,283 7,671

Invested Capital (IC):Plus normal cash (2% of sales) 456 421 422 379 410 427 445 463 Plus accounts recievable 1,976 2,442 2,224 1,897 2,154 2,350 2,558 2,778 Plus inventories 59 51 50 52 54 54 54 54 Plus prepaid expenses & other current assets 828 695 385 738 798 831 866 901 Non-interest bearing current assets 3,320 3,608 3,081 3,067 3,416 3,662 3,923 4,196 Less accounts payable 925 1,208 988 797 892 984 1,050 1,045 Less income taxes 266 228 332 203 226 238 253 265 Less Accrued payroll 1,146 987 1,026 920 995 1,036 1,079 1,123 Less Other Misc. Current Liabilities 554 551 595 595 595 595 595 595 Non-interest bearing current operating liabilities 2,891 2,974 2,941 2,515 2,708 2,853 2,977 3,028 Net operating working capital 429 634 140 552 708 809 946 1,168 Net PP&E 22,448 22,843 24,160 24,778 25,234 25,509 25,680 25,624 Plus PV of operating leases 10,110 10,423 13,261 13,618 13,919 14,158 14,321 14,490 Plus misc. assets 1,528 1,158 1,244 1,244 1,244 1,244 1,244 1,244 Plus net other operatings assets 34,086 34,424 38,665 39,641 40,396 40,912 41,245 41,358 Less other long term liabilities 3,525 3,178 3,246 3,246 3,246 3,246 3,246 3,246 Invested Capital 30,990 31,879 35,559 36,947 37,858 38,474 38,945 39,280

Free Cash Flow (FCF):NOPLAT 4396 5703 6346 5824 6504 6879 7283 7671Change in IC -4730 889 3680 1388 911 616 471 335FCF 9126 4814 2665 4436 5592 6264 6812 7336

Return on Invested Capital (ROIC):NOPLAT 4396 5703 6346 5824 6504 6879 7283 7671Beg. IC 35720 30990 31879 35559 36947 37858 38474 38945ROIC 12.3% 18.4% 19.9% 16.4% 17.6% 18.2% 18.9% 19.7%

Economic Profit (EP):Beg. IC 35720 30990 31879 35559 36947 37858 38474 38945x (ROIC - WACC) 7.7% 13.8% 15.3% 11.8% 13.0% 13.6% 14.3% 15.1%EP 2746 4272 4874 4182 4798 5131 5507 5873

McDonald'sWeighted Average Cost of Capital (WACC) Estimation

Cost of Equity: ASSUMPTIONS:Risk-Free Rate 0.67% 10yr treasuryBeta 0.92 Equity Risk Premium 5.15% Henry FundCost of Equity 5.41%

Cost of Debt:Risk-Free Rate 0.67%Implied Default Premium 1.74%Pre-Tax Cost of Debt 2.41% YTM on 15 yr bondMarginal Tax Rate 24%After-Tax Cost of Debt 1.82%

Market Value of Common Equity: MV WeightsTotal Shares Outstanding 757Current Stock Price $218.74MV of Equity 165,520.56 77.93%

Market Value of Debt:Short-Term Debt -$ Long-Term Debt 46,876$

MV of Total Debt 46,876.00 22.07%

Market Value of the Firm 212,396.56 100.00%

Estimated WACC 4.62%

McDonald'sDiscounted Cash Flow (DCF) and Economic Profit (EP) Valuation Models

Key Inputs: CV Growth of NOPLAT 1.90% CV Year ROIC 19.7% WACC 4.62% Cost of Equity 5.41%


DCF Model:Free Cash Flow (FCF) 4,436 5,592 6,264 6,812 7,336 Continuing Value (CV) 255,098 PV of FCF 4,240 5,109 5,470 5,687 212,959

Value of Operating Assets: 233,466 Non-Operating AdjustmentsInvestments in and advances to affiliates 1471

Less:Underfunded pension (42) Total value of debt (46,876) ESOP (1,152)

Value of Equity 186,867 Shares Outstanding 746Intrinsic Value of Last FYE 250.39$ Implied Price as of Today 255.79$

EP Model:Economic Profit (EP) 4,182 4,798 5,131 5,507 5,873 Continuing Value (CV) 216,153 PV of EP 3,997 4,384 4,482 4,597 180,447

Total PV of EP 197,907 Invested Capital (last FYE) 35,559 Value of Operating Assets: 233,466 - Non-Operating AdjustmentsInvestments in and advances to affiliates 1471

Less:Underfunded pension (42) Total value of debt (46,876) ESOP (1,152)

Value of Equity 186,867 Shares Outstanding 746Intrinsic Value of Last FYE 250.39$ Implied Price as of Today 255.79$

McDonald'sDividend Discount Model (DDM) or Fundamental P/E Valuation Model


EPS 7.53$ 8.48$ 9.04$ 9.70$ 10.29$

Key Assumptions CV growth of EPS 2.00% CV Year ROE -374.45% Cost of Equity 5.41%

Future Cash Flows P/E Multiple (CV Year) 29.5 EPS (CV Year) 10.29 Future Stock Price 303.42 Dividends Per Share 4.21 6.23 6.91 7.33 8.05 Discounted Cash Flows 3.99 5.61 5.90 5.94 245.78$

Intrinsic Value as of Last FYE 267.22$ Implied Price as of Today 272.98$

McDonald'sRelative Valuation Models

EPS EPS Est. 5yrTicker Company Price 2020E 2021E P/E 20 P/E 21 EPS gr. PEG 20 PEG 21WEN Wendy's Company $21.47 $0.54 $0.69 39.76 31.12 9.9 4.02 3.14 CMG Chipotle Mexican Grill $1,297.47 $15.29 $20.95 84.86 61.93 18.0 4.71 3.44 QSR Restaurant Brands Intl. $71.93 $2.78 $3.61 25.87 19.93 5.4 4.79 3.69 YUM Yum! Brands $92.27 $3.19 $3.91 28.92 23.60 10.7 2.70 2.21 Jack Jack In The Box $82.47 $4.18 $4.98 19.73 16.56 7.7 2.56 2.15

Average 39.83 30.63 3.76 2.93

MCD McDonald's $218.74 $7.53 $8.48 29.0 25.8 5.4 5.4 4.8

Implied Relative Value: P/E (EPS20) $ 299.99 P/E (EPS21) 259.70$ PEG (EPS20) 152.83$ PEG (EPS21) 133.98$

McDonald'sEffects of ESOP Exercise and Share Repurchases on Common Stock Account and Number of Shares Outstanding

Number of Options Outstanding (shares): 15Average Time to Maturity (years): 5.80Expected Annual Number of Options Exercised: 2.52

Current Average Strike Price: 124.21$ Cost of Equity: 5.41%Current Stock Price: $218.74

Fiscal Years Ending Dec. 31 2020E 2021E 2022E 2023E 2024EIncrease in Shares Outstanding: 2.52 2.52 1.31 0.00 0.00Average Strike Price: 124.21$ 124.21$ 124.21$ 124.21$ 124.21$ Increase in Common Stock Account: 312.7 312.7 162.6 - -

Change in Treasury Stock 2,200 2,200 2,200 2,200 2,200Expected Price of Repurchased Shares: 218.74$ 230.57$ 243.04$ 256.18$ 270.04$ Number of Shares Repurchased: 10.1 9.5 9.1 8.6 8.1

Shares Outstanding (beginning of the year) 746 739 732 724 715Plus: Shares Issued Through ESOP 2.5 2.5 1.3 0.0 0.0Less: Shares Repurchased in Treasury 10.1 9.5 9.1 8.6 8.1Shares Outstanding (end of the year) 738.8 731.7 724.0 715.4 707.3

McDonald'sValuation of Options Granted under ESOP

Current Stock Price $218.74Risk Free Rate 0.67%Current Dividend Yield 2.30%Annualized St. Dev. of Stock Returns 20.84%

Average Average B-S ValueRange of Number Exercise Remaining Option of OptionsOutstanding Options of Shares Price Life (yrs) Price GrantedRange 1 14.6 124.21 5.80 78.90$ 1,152$

Total 15 124.21$ 5.80 103.02$ 1,152$

McDonald'sPresent Value of Operating Lease Obligations

Fiscal Years Ending Dec. 31 2015 2016 2017 2018 2019Year 1 1274.0 1303.0 1152.0 1145.0 1161.9Year 2 1171.5 1200.0 1087.0 1083.0 1132.8Year 3 1058.5 1103.0 997.0 1001.0 1091.4Year 4 955.9 1001.0 904.0 909.0 1052.6Year 5 858.4 892.0 805.0 831.0 1010.3Thereafter 6783.5 6754.0 6912.0 7297.0 13573.6Total Minimum Payments 12101.8 12253.0 11857.0 12266.0 19022.6Less: Cumulative Interest 1700.0 1686.3 1747.3 1843.1 3747.9PV of Minimum Payments 10401.8 10566.7 10109.7 10422.9 15274.7

Implied Interest in Year 1 Payment 34.6 250.7 254.7 243.6 251.2

Pre-Tax Cost of Debt 2.41% 2.41% 2.41% 2.41% 2.41%Years Implied by Year 6 Payment 7.9 7.6 8.6 8.8 13.4Expected Obligation in Year 6 & Beyond 858.4 892 805 831 1010.3

Present Value of Lease PaymentsPV of Year 1 1244.0 1272.3 1124.9 1118.1 1134.6PV of Year 2 1117.0 1144.2 1036.4 1032.6 1080.1PV of Year 3 985.5 1026.9 928.3 932.0 1016.1PV of Year 4 869.0 910.0 821.9 826.4 957.0PV of Year 5 762.0 791.9 714.6 737.7 896.9PV of 6 & beyond 5424.2 5421.3 5483.6 5776.1 10190.1Capitalized PV of Payments 10401.8 10566.7 10109.7 10422.9 15274.7

mcdonald’s (mcd) september 10, 2020 · 2020. 12. 4. · year franchise agreement, mcd maintains...

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