NOTE ALL PERSONAL OPINION, NOT FINANCIAL ADVICE

INTRODUCTION:

MCD's golden arches are famous worldwide, it's precisely this strong goodwill that allows their business to remain attractive to franchisees for so long. The consistent quality of each MCD store regardless of where it is on earth, the large cost advantage due to how large the franchise has become and Quality of franchisee give MCD strong cash flows. However, MCD might be overly hyped by investors who assumes that the firm can just keep opening stores regardless of the macro environment which is not true.
INVESTMENT THESIS 1:
Strong Quality Control (QC)
MCD has a strong QC that many other fast food brands are unable to replicate. From the ingredients that they receive from suppliers (Fries, Cooking Oil, Nuggets etc.) to the training procedure (Timing to cook, how to maintain freshness, stringent training etc.) (SOURCE). MCD has consistently produced quality products to its customers, this consistent quality is something customers are used to throughout their time with MCD allowing MCD to build strong brand goodwill. Furthermore, for other fast food chains to start their QC process now, it will be an uphill battle as there needs to be an overseer on what quality should be the standard and how they should go about fixing the quality. Strong QC also means that the experience in every MCD regardless of location will be consistent, allowing every MCD across the world to tap into MCD’s strong global goodwill.
MCD has a Performance and Customer Excellence program, also known as PACE. PACE is a program by MCD to help consult poorly run franchises ensuring that standards are met.
INVESTMENT THESIS 2:
Cost Advantage
There are 40,000 MCD stores globally compared to 50,000+ YUM Brand stores (KFC, Pizza Hut and Taco Bell). Although YUM Brand has a higher store count, most of these brands use conflicting ingredients e.g. KFC uses buns for burgers whereas Pizza Hut doesn't use buns. So the actual economy of scale enjoyed by MCD is higher compared to other fast foods.
To illustrate, as of FY22 MCD’s Franchise Expense as a %Revenue is 10.1% only as compared to YUM’s 26.2%
INVESTMENT THESIS 3:
Franchisee Requirement
MCD is a big enough brand to be stringent in their franchisee selection, high initial investment (SOURCE) and large time commitment through Mcdonald University. Meaning only high quality franchisees get to run MCD. In fact, MCD is one of the most popular franchise restaurants (SOURCE). So with higher quality franchisees means that they will carry the MCD brand to a greater height having more commitment/experience, deeper pockets to sustain through down periods and dedication to innovate.
Zero Territorial Franchising – Unlike nearly all franchisers during the 1950-60’s and even today, McDonald’s does not grant regional licenses to a single franchisee…Burger King under Pillsbury, for example, was forced to acquire Diversifoods in 1985 to gain complete control over its largest franchisee as a means to improve quality. Conversely, McDonald's only allows additional stores per franchisee once baseline requirements have been met on a store-by-store basis.
REVENUE:
When forecasting Stores,
the rationale I took was from “We want to continue to drive strong top line momentum so that we have that momentum through these pressures and then, of course, out of the pressures and begin to kind of recover margins and gain leverage as we go forward.” - 2022 Q4 Earnings Conference.
Management has given guidance in their 2022 Q4 Earnings conference that they expect to net add 1500 stores in 2023. However, this number was taken before the war in Ukraine had fully begun. So, I’d assume that management only meets about 33% of their goal.
Going forward, I’d assume that management grows at an elevated amount due to all the marketing spend they made on their Accelerating the Arches programme for the next 3 years while inflation stabilizes. Beyond that, I’ll assume that management focuses on monetizing these stores.
When forecasting Revenue/Store,
I’m cautious in increasing the revenue/store to a significant extent. MCD is a fast food restaurant where their value proposition comes from being able to purchase a meal at affordable prices. The quantity sold could arguably be higher due to “shrinkflation” that pushes consumers to buy a higher quantity of food in order to be satisfied. Management constantly talks about how they take pride in being the most value for money meal amongst their competitors. But, MCD has to keep somewhat in line with inflation to protect margins. In the first 3 years of Accelerating the Arches programme, I’d assume that Revenue/Store grows at a steady rate but overtime when inflation abates management slows price growth to continue their belief in providing value for money.
COST:
Due to tension in Europe, MCD has to provide relief to their European franchisee.
MCD has stated that they are looking towards using data to optimize their restaurants and push out areas of inefficiency in the operations. As seen from 2022 Q4 and 2023 Q2 Earnings Conference. “With about 90% of our business currently coming through digital channels in that market, it was remarkable to see how the market has forged digital relationships with customers. China is also making tremendous progress in running the restaurants more efficiently, all with the use of data and technology.” - 2023 Q2 Earnings Conference.
When forecasting COGS,
the main cost in this category comes from stores which are owned by MCD corporation themselves. From FY21 to FY22 due to the number of MCD owned stores declining they are less affected by inflation so there is a fall in COGS. So, seeing that MCD wants to maintain 95% franchised we can assume that cost cutting comes from economies of scale or better data usage allowing MCD restaurants to be better optimized.
When forecasting SG&A,
as the cost of labor is elevated due to the tight labor market I’d assume that it takes 3 years before SG&A regresses back down to pre covid levels.
CapEX and D&A:
When forecasting D&A,
opting for less granularity I’d assume it follows historical trends.
When forecasting CapEX,
I’d assume CapEX spend remains elevated as seen in FY22 for the next 3 years before tapering down.
Sanity Check:
MCD has a ROIC of 21% (SOURCE)
[INSERT] I'd assume that MCD ROIC increases as they invest in using more data to better optimize their restaurants.
WACC:
Cost of Equity
US bond is AA+, yield spread (1M Avg) 0.66
US 10Y T-Bond Yield (1M Avg) = 4.72
RFR = 4.06%
4050 = (4050 * 4.25%) * (1+16%) / (1+R) + [((4050 * 4.25%) * (1+16%)) * (1+3.82%) / (R - 3.82%)] / (1 + R) ^ 2
R = 10.3%, ERP = 6.24%
Beta (SOURCE) = 0.64
COE = 8.05%
Cost of Debt
MCD bond is BBB
Marginal Tax Rate = 21%
BBB bond yield (SOURCE) = 6.29%
AT Bond Yield = 4.97%
Weightage
Market Price (5D Avg) = $261
Shares O/S = 731M
Market Value of Equity = 190791M
[INSERT]
Weighted average life of 8 Years, FY22 rent expense = 1476.1M
MV Lease Liability = 18232M
As MCD does not break down the debt obligation, I took BV debt.
BV debt = 35904M
Total Liability = 54136M
%Debt = 22.1%
%Equity = 77.9%
WACC = 7.37%
OTHERS:
Net Operating Loss
Given that MCD does not explicitly break down their NOLs stating “the Company had net operating loss carryforwards of $407.5 million, of which $174.6 million has an indefinite carryforward. The remainder will expire at various dates from 2023 to 2040.” To be conservative, I’ll only consider 174.6M of NOLs.
Stock Options
In 2022, MCD has 11.4M shares of options contract at Weighted Average Strike Price of $172.27 which is In-The-Money(ITM).
So using the treasury stock method,
Total Cash from options = 1963.88M
Average Stock Price (5D Avg) = $261
Shares able to buy back = 7.5M
Net Addition = 3.9M Shares.
CONCLUSION:
Ultimately, I value MCD at $191.82 per share. I believe that MCD is overly hyped by investors who are way too optimistic about MCD's store count going up at ever increasing rates. This is unrealistic given current macro environment making any new store opening at Europe returning significantly less than average returns. The property crisis in China eroding confidence of franchisees and the strong Asian competitors e.g. Jollibee who caters more to local taste buds. I do not believe that MCD can continue strong growth for as long as investor's expect. However, given the business model of MCD, slowing growth could mean a death sentence as margins are more or less fixed. The business model is one where the end goal is absolute profits.
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“Approximately 93% Of McDonald’s restaurants worldwide are owned and operated by independent local business owners.” (SOURCE)
“Franchised restaurants represented 95% of McDonald's restaurants worldwide at December 31, 2022. ” - 2022 10-K