hey YouTube I'm Jimmy in this video I'm gonna walk through my analysis of
McDonald's ticker symbol MCD this is the 18th video in our series over analyzing
all 30 stocks in the Dow Jones Industrial Average you can see a link
in the description below to all the other videos once we're done with all of
our analysis along we're going to take the results and we're going to try to
convert it into three different portfolios a value portfolio a dividend
portfolio and a growth portfolio so McDonald's is actually an interesting
company from a business perspective so McDonald's owns and operates a handful
of restaurants and then they franchise the rest there in more than a hundred
countries and management has stated that it's their long-term goal for McDonald's
to have at least 95 percent of their restaurants franchised leaving just 5%
of the restaurants for the company to own and operate now with that five
percent many times what they do is that's where they experiment they and
expand experimented with pricing new products things like that so that's
really why they want to keep some of them so as of the end of last quarter
McDonald's had about 37,000 locations here's a chart of the number of
restaurants that they had going back to 2008 and as we could see that they've
been steadily opening new restaurants every year this is likely a good thing
for growth and revenue but we'll come back to that in a minute now we can
break this chart down into franchises and company owned restaurants the orange
bars are franchises and the gray bars are company-owned right now McDonald's
operates about 8 percent of the restaurants so they're a bit above their
long-term goal but it's not too bad now one of the interesting things about
McDonald's is the way they set up their franchising so they have the
conventional franchise model which basically the way that works is
McDonald's generally owns the land that the restaurant is on so under this model
of franchisee we'll rent the building from McDonald's and they will pay them
royalties which is a it's based on a percentage of the sales of that
particular store and usually McDonald's were throwing some minimums in there
that the store has to meet now McDonald's claims that this gives them
significant free cash flow actually read that word significant in their 10k
and the very first thought I had when I read that they get significant free cash
flow is that this is probably a good candidate to use discounted cash flow to
try to value them and I think it's important to keep this type of thing in
mind if you're researching a company and you come across something in your
readings that and the company says oh we have significant free cash flow or our
growth is better than peers perhaps that company's give you an indication
and as to how we should go ahead and try to value them now we actually saw this
thing in our last video which was our JP Morgan analysis and they did the same
thing there they came on and said that they measure success in their business
by looking at the tangible book value of the business well what we ended up doing
is we ended up using tangible book value as a way to value the company now this
doesn't always work but I find that it's usually a pretty good place to start
okay go back to McDonald's now the conventional franchise model isn't the
only model that they use they also have something that they call the
developmental licensing model and here the franchisee they're actually the
licensee in this scenario but either way they're what they do is they put up all
the capital they own the land they own the building they own everything they do
all the fixtures they set everything up then what McDonald's does for using the
brand and for helping them with logistics and all that they get a
percentage of revenue then they have their final version is called the equity
investments now you may have heard back in 2017 McDonald's actually sold their
China and Hong Kong businesses well they retained 20% of that business so that
type of ownership would fall into that category so we know a McDonald's does
they own restaurants but how big are they really relative to the rest of the
restaurant market so according to a study done by Euromonitor International
the global informal eating out segment generated about 1.2 trillion dollars in
revenue back in 2016 that's the last data I could find now this chart this is
a number of locations for many of the largest brands in the world and as we
could see Yum Brands is the largest a of the most locations
they own KFC Pizza Hut Taco Bell and a handful of other brands then there the
green bars then McDonald's there the red bars and you can see that they're the
second largest now actually don't have Burger King on here and they've done a
lot lately they are a couple years ago they
more merged with Tim Hortons and they merged with Popeyes so there's been a
lot going on with that I probably should have had them on the chart but we're
missing them but you could see that they would fall somewhere in between Wendy's and
McDonald's so no they would they would be the third largest okay so before we
go ahead and try to value McDonald's stock let's look at some of their
numbers so this is a chart of McDonald's revenue going back to 2008 and as we
could see they've been struggling a bit in recent years now when we add net
income we can see that net income dipped back in 2013 but then it looks like it
was either a little bit flat and maybe it moves slightly higher now if we
eliminate revenue then we can get a better look at just net income and we
could see then that what actually happened is that net income went down in
2014 and 2015 but then it did in fact start moving
high so in order for net income to move higher while revenue is going down that
must mean that they improve their margins now we have to find out how and
is it sustainable as ultimately the question and that will be very useful to
how we come up with valuation so here's net income margins and as we could say
net income margins started moving higher right around when we would expect them
to right now they're right around 24% which is the best level that they've
been at over the past decade okay so now that was expected but it doesn't tell us
why they improved so now if we had even our margins to this we could see that
even our margins moved up right in line with net income margins now since EBITDA is profit or really earnings which is the same thing
earnings before interest taxes depreciation and amortization then what
this tells us is that margins did not improve it had nothing to do with
interest taxes or depreciation so we've learned a little something we've learned
why it didn't happen but we haven't really learned why it did happen yet
okay now moving up the income statement we can throw in gross margins and now we
could see that gross margins there the red bars
EBITDA margins there the green bars and net income margins are the purple bars
we could see that gross margins have moved up right in line with the rest of
them now this is good because this tells us that ultimately what must have
happened is their cost of goods relative to
revenue improved now I did a bit of digging and it seems that the
improvement to margins apparently down the whole income statement were due to
price increases now this is dangerous because if they price themselves too
high their revenue will continue to decline and no matter how good their
margins are the stock price is likely to follow suit now before we take a peek at
the stock chart let's see what we think let's try to come up with our own
valuation and then we could see if it's worth buying
so this is our discounted cash flow calculation and we're using consensus
estimates for free cash flow going out the next few years we're using a
weighted average cost of capital of 7.4 percent then we use the perpetual growth
rate of 2.5 percent that's been our standard and all the research that we've
done it's about the long-term growth of the economy it's nothing else that's a
big conservative but it's what we've been doing now if you're wondering how
we calculated these you'll see a link in the description below for different
types of videos that are tied to these topics the biggest question we usually
get is about the cost of equity for that we use the capital asset pricing model
there's a link in the description below to that video so with these free cash
flow estimates we get a fair value of one hundred and sixty three dollars per
share and this brings us to McDonald's chart and as we could see the chart the
stock has been up a bit recently now if we look at their current PE valuation we
can see that their forward p/e is about 22 X right now their three-year average
for their forward p/e is 21 X their 5-year average is 20 X and their 10-year
average is just 18x so it seems that according to their own history
McDonald's may be a bit over price that's true for the PE valuation and for
our discounted cash flow valuation now what I think happened is that I think
investors want a bit crazy when they saw the improvement in margins but
unfortunately that really won't be sustained for a long period of time now
I see that McDonald's we saw that McDonald's continues to open new stores
and that I know that they also had some pretty good Sam soar sales numbers but
in my opinion if McDonald's were to revert if McDonald's chart were to
revert back to any one of their averages the stock
price is likely to fall now one thing that could change is that if perhaps it
would make a big acquisition I know the Burger King made a few big acquisitions
in recent years that helped them you know get much larger on the other hand
if they were to perhaps lower costs a bit and try to improve margins that way
I know that they have spent some time remodeling a lot of their locations and
that seems to be helping some of the same store store sales growth which is
good from a revenue perspective but we're gonna need revenue to turn around
we saw what that chart looks like and it doesn't look terribly great right now so
until they get that in place I'm not sure how interesting this will be for
now I think from a analysis perspective I'm not too confident in McDonald's
stock certainly not at this price but what do you think do you think
McDonald's is a good buy at this level let me know what you think in the
comments below and do you think it belongs to any of our portfolios they do
have a dividend yield of about two and a half percent which is slightly above the
S&P 500 so perhaps they have a home in the dividend portfolio but let me know what
you think in the comments below and if you haven't done so already hit the
subscribe button and thanks for sticking with me all the way to the end of the
video and I'll see in on our next video thanks