McDonald's For Long-Term Capital Appreciation

| About: McDonald's Corporation (MCD)

McDonald's (NYSE:MCD) stock has declined considerably from its high in recent months. Declining more than 13% from its 52-week high and currently around $1 away from its 52-week low set in June 2012, I find it timely to write this article at the moment. There are many merits about McDonald's that one should pay attention to, from the fact that it pays a 3.55% dividend annually to its rapidly growing ROE (Return On Equity). If you had read my previous articles, I like stocks with a few qualities: good value, good growth and fundamentals, a desirable chart and a strong balance sheet.

But first, here is a snapshot of the company.


McDonald's Corporation franchises and operates McDonald's restaurants in the global restaurant industry. Its restaurants offer various food items, soft drinks, coffee, and other beverages. The company operates approximately 33,500 local restaurants serving approximately 69 million people in 119 countries each day. McDonald's Corporation was founded in 1940 and is headquartered in Oak Brook, Illinois.


Price (31.10.2012) $86.80
Market Cap 87.53B
Income (2011) 5.50B (Trailing P/E: 16.35)
Sales (2011) 27.44B (P/S: 3.19)
Book Value Per Share $13.92 (P/B: 6.24)
ROE (Return On Equity) 38.40%
EPS Past 5 Years 18.13%
Debt/Equity 0.97
Dividend $3.08 (3.55%)
Payout Ratio 52.17%

1. Good Value

McDonald's fulfils the criteria of mine. Its trailing 16.4X earnings is lower than its 10-year average of 17.3X earnings. The number may seem a little high for some investors but it is low compared to other competitors with Yum! Brands (NYSE:YUM) trading at 20.6X, Chipotle Mexican Grill (NYSE:CMG) trading at 29.6X earnings and Tim Hortons (THI) trading at 19.4X earnings.

On the other hand, its P/S is at 3.19 and its P/B at 6.24. These indicators show that McDonald's stock price may be slightly overvalued but all these numbers, like the above P/E ratio, are just in-line with its competitors. Yum! Brands has a P/S of 2.33 and a P/B of 14.43; Chipotle Mexican Grill has a P/S of 3.05 and a P/B of 6.14.

2. Good Growth And Fundamentals

Firstly, McDonald's has fast-growing earnings. As seen from the above snapshot, McDonald's grew at a fast 18.13% year-over-year for the past 5 years, a remarkable number for a company with a market cap of 87.53B. Its EPS, over the past 10 years, had also been growing every year for the past 10 years with the exception of 2007, as shown in the table below.

EPS 2002 $0.77
EPS 2003 $1.18
EPS 2004 $1.79
EPS 2005 $2.02
EPS 2006 $2.29
EPS 2007 $1.93
EPS 2008 $3.76
EPS 2009 $4.11
EPS 2010 $4.58
EPS 2011 $5.27

Secondly, McDonald's ROE (Return On Equity) number had increased astronomically over the past 10 years, growing from just 8.70% to 38.40% today, as seen in the table below. The definition for ROE is the amount of net income returned as a percentage of shareholders' investments. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. A rising ROE indicates that a company's management are using its shareholders' money more effectively, which is good both for the company and its shareholders.

ROE 2002 8.7%
ROE 2003 12.3%
ROE 2004 16.0%
ROE 2005 17.2%
ROE 2006 22.9%
ROE 2007 15.7%
ROE 2008 32.2%
ROE 2009 32.4%
ROE 2010 33.8%
ROE 2011 38.2%
ROE 2012 Latest Quarter 38.4%

Thirdly, McDonald's has been buying shares back over the past 10 years, with its total shares outstanding declining 20.47% in the 10 years, from 1.27B in 2002 to just 1.01B today. As shareholders do not own the whole company, share buybacks bode well for shareholders as they are able to own a bigger part of the company without increasing the number of shares they own. Below shows a table of McDonald's shares outstanding number over the past 10 years.

Shares Outstanding 2002 1.27B
Shares Outstanding 2003 1.26B
Shares Outstanding 2004 1.27B
Shares Outstanding 2005 1.26B
Shares Outstanding 2006 1.20B
Shares Outstanding 2007 1.17B
Shares Outstanding 2008 1.12B
Shares Outstanding 2009 1.08B
Shares Outstanding 2010 1.05B
Shares Outstanding 2011 1.02B
Shares Outstanding 2012 latest quarter 1.01B

Fourthly, McDonald's had been paying dividends yearly since 1976 and had been increasing dividends yearly since then, signifying 35 years of consecutive dividend increases (as they only started dividends in 1976, 1977 would be the first year that they increased dividends). This is a good sign that the company has the ability to generate more than enough earnings yearly- to be able to fund internal operations, save money, and even return money to shareholders at an increased rate yearly at the same time. This proves that McDonald's has a successful business model that is able to consistently generate income for the company.

Fifthly, McDonald's days inventory number have also been decreasing steadily over the past 10 years, which means goods stay in the inventory for a shorter period of time. Days Inventory is a financial measure of a company's performance that gives investors an idea of how long it takes a company to turn its inventory into sales. This is another positive point about the company as this is a sign that sales are improving. Below shows the days inventory number over the past 10 years.

Days Inventory 2002 3.80
Days Inventory 2003 4.00
Days Inventory 2004 4.10
Days Inventory 2005 3.80
Days Inventory 2006 3.70
Days Inventory 2007 3.10
Days Inventory 2008 2.70
Days Inventory 2009 2.80
Days Inventory 2010 2.80
Days Inventory 2011 2.60
Days Inventory 2012 latest quarter 2.40

3. Desirable Chart

McDonald's weekly chart:

Above shows McDonald's weekly chart, which illustrates clearly the strong, impressive uptrend McDonald's stock had been in over the past 8 years, and if one looks at a chart with an even longer time frame, the uptrend would have been even more impressive. With a stable business model and a team of efficient management, McDonald's stock has managed to achieve stratospheric price increases over the past few decades.

From the above chart, McDonald's stock had steadily rose more than 330% over the past 8 years. Additionally, McDonald's stock price stayed between $40 and $55 during the 2008-2009 recession, when most stocks declined 50% or more. This emphasizes its stability, how popular its brand is, how recession-proof it is and how it is a leader within its industry. This is a stock, in my opinion, not to be left out of any investor's portfolio, especially on the recent dip which brought the stock close to its 52-week lows.

4. Strong Balance Sheet

Before I start on anything, as always, here is McDonald's balance sheet.

If you take a look at the above balance sheet, its cash and cash equivalents has increased from $1.796B in the year ended December 31st, 2009 to $2.336B in the year ended Dec. 31st, 2011, representing a 30.1% increase in cash over the past 3 years, a remarkable increase for a time frame of just 3 years.

McDonald's current assets, which is basically assets that can be converted to cash immediately (cash is also included), has also grown faster than its current liabilities, which are liabilities that it has to pay in the near-term. From 2009 to 2011, the company's current assets had grown 28.9%, from $3.416B to $4.403B today, while its current liabilities had grown only 17.4%, from $2.989B to $3.509B.

McDonald's has $32.99B in assets and $18.60B in liabilities as of Dec. 31st, 2011

McDonald's also does not have any preferred stock, which is a good sign for the company- it does need to pay extra special dividends which would only drain its cash reserves faster. A company which has preferred stock also shows how cash-strapped it is to have to borrow money from its shareholders, technically, at higher interests than normal (special dividends, etc.).

These are key things I look out for when analyzing a balance sheet.

Key Risks/Flaws

Firstly, McDonald's debt/equity ratio is at a high 0.97, which equates to about 14B in debt. This is quite a high number to me, as I normally would like a company's debt to be much lower than its equity (I would normally want Debt/Equity to be <0.5). This ratio shows the proportion of equity and debt the company is using to finance its assets, and the higher the ratio, the more debt, rather than equity is financing the company. A high level of debt compared to equity can result in volatile earnings and large interest expenses.

Secondly, its profit margins could be reduced due to the rising food prices. Below shows the prices of wheat (futures), the ingredient that McDonald's has to use most in its burgers. It has been rising steadily over the past year, rising about 35% Year-To-Date (YTD), as shown in the chart below. Besides wheat, other commodities like the different meats and even coffee, widely served in McDonald's outlets around the world had also been increasing in price rapidly. All these are potential causes of reducing McDonald's profit margins and also its profits.

The Takeaway

McDonald's stock is a great stock to buy over the long term, as proven from its many qualities stated above. Although it has some flaws, like any other company has, I believe that all these merits, including its steady dividend growth, good chart and strong fundamentals, make McDonald's a favorable investment for any investor's portfolio for its long-term growth and appreciation.

Disclosure: I am long MCD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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