Mc Donald’s – MARKET SPIDER (2024)

To properly assess the attractiveness of an industry, it is useful to look at the Five Forces model ofPorter. This isconsistsof the rivalry among competing sellers, the buyer bargaining power, thesupplier bargainingpower,the threatof substitutionandpotentialnewentrants.

The rivalry among competing sellers is very high in the fast-food business due to a very high numberof competitors. Since there exists a wide variety of different restaurant types, the market has manypotential entrants. Furthermore, market entry barriers are very low. Low buyer’s switching cost buthighfirm’s fixcosts,makesthe competitiona reallystrongforce.

As the rivalry among competitors, the buyer bargaining power is also very strong. Due to the hugeavailability of substitutions and transparent information about price and quality, buyers are in astrong position to make their own decision about their purchase. The low switching cost and thepopularity of other competitors (such as Burger King, Starbucks, etc.) makes it not a big deal to visitanotherrestaurant.

However, supplier bargaining power is a weak force. A large number of suppliers put Mc Donald’s ina position where they do not rely on just one big supplier. Furthermore, Mc Donald’s own logisticnetworkweakens the bargaining powerof its supplier.

The threat of substitutions also remains pretty high for McDonald’s. Not only the heavy competitionwithin the fast-food industry but also the competitors of other industries, makes it hard forMcDonald’s to escape the strong competitive forces. Not only otherfast foodcompanies competewithMcDonald’s butalsonormalrestaurants,deliveryservicesandsupermarketstoa certainextent.

The threat of new entrants can be considered as moderate. Although entry barriers are very low, McDonald’s strong brand and reputation is a very valuable immaterial asset which takes decades tobuild. Its brand is worldwide known and people associate positive emotions with it. Therefore, itsbrandis a moatwhichmakes itharder for othercompanies to competewithMcDonald’s.

Losing market share: If the company loses market share, it will weaken its competitiveness anddifficulties to sustain a high profit margin may occur. Causes for the decline in market share could beif the company fails to reinvest into restaurants, it fails to anticipate consumer preferences or if itdamages their brand image in any way. Due to a highly competitive environment, competitors wouldtakeoverMcDonald’smarketshare rapidly.

Debt problems: McDonald’s huge amount of debt is a threat to the business. If net income drops fora longer period of time, credit agencies could downgrade the company’s rating, which would makethedebtforMcDonald’s far moreexpensive.

Political impact:Political actions could harm McDonald’s in multiple ways. First, increased socialstandards like the minimum wage are raising costs and make its business model less profitable.Furthermore, geopolitical tensions that could trigger restrictions on McDonald’s can be seen as themost dangerous political risk. McDonald’s is a global diversified company that would suffertremendously from tariffsor from evenwhole bans inonecountry.

By looking at the net profit margin, you see that this ratio has increased by around 60% in the lastfour years. This seems incredible, especially giving the fact that McDonald’s is more on the end of itsproduct cycle and revenue is falling. The reason for this big increase lies in the re-franchising process.In 2014, around 80% of restaurants were run by franchisees. Now this rate is at 93%. So, McDonald’savoidcostsby delegatethese toitsfranchiseeswhichmakes the businessmoreprofitable.

Furthermore, the tax cut also minimized their cost. It is essential to know, that these factors aretemporary because they cannot repeat a second time. This will be important for the futurepredictionof its businesslater.

The asset turnover is 0,525. With every dollar worth of assets, the companyis able togeneratearound 50 cents of income. Around 10% are not assets directly related to the operating business, likeIntangibles or Receivables. Therefore, its effectiveness in generating cash with assets isactuallyhigher. However, there is a steady decline of this ratio in the last years. This is predominantly causedbyanincrease inotherassets.

These assets include more intangible assets, like Goodwill. By looking at assets directly related to theoperatingbusinessofMcDonald’s,you seethatthe assetturnover ratio isremainedquite stable.

The graphic puts emphasis on the management’s strategy to offer differentiated products in acompetitive environment with normally low profit margins, especially in the conventional restaurantbusiness.The extraordinary profit margin of McDonald’s is an indicator that McDonald’s hascompetitiveadvantagesora socalled“moat”.This iscaused byitsbrands and itseconomiesofscale.

Together with the total leverage weare able toderive some more measures of productivity, namelythe ReturnonEquity(ROE)and the Returnon Assets (ROA).

Negative Equity:Negative Equity was caused by McDonald’s share buybacks. When a company buysback its own share when the share price is about the book value per share, the companyhas tokeepthe repurchased shares in the balance sheet and cannot just eliminate those. The difference betweenthe book value per share and the market price needs to be subtracted from the equity. Due toMcDonald’s massive repurchases, the negative equity grew a lot over the last years. However, it isworth mentioning, that McDonald’s is a real estate company that has a lot of assets (highly valuablereal estateobjects)thatarelistedbyitspurchaseprice notit*marketprice inthe balancesheet.

Therefore, McDonald’s is not facing any bankruptcy risks or something like that due to its negativeequity.

You can find more information on McDonald’s risks liked to its negative equity here.

As you can see in the first row, it says that -6 > 1. Mathematically this is a wrong equation. However,McDonald’s has negative equity. Therefore, its debt ratio is about 100% and its book value is infinitewhichmakesthequalitycriteria failthe requirementofa ratio below 1.

That McDonald’s failed at every single qualitycriteriashows that it lacks financial strength and isfinanced quite risky. Moreover, their cash flow stream is not as constant as we saw in the lastcriteria. This makes its finance structure even more dangerous and prone to disruptions andunpredictable risks.

Due to negative equity and a historical low bond yield, wemustmake some adjustments to thevaluation. To take the high debt into account wehave touse a measuring method that does this likethe Enterprise Value. This figure is calculated by the market capitalization plus debt minus liquidity.Therefore, EV/EBIT shows how many years it would take to pay the entire price of the company justby using its EBIT.

For the Discounted Cash Flow Analysis, I assumed equity costs of 10%. Due to the volatility and therisks of the stock market, I always take a minimum of 8% of equity cost for all stocks. In the case ofMcDonald’s,Iadd 2%morebecauseof its poorfinancial statement.

Thisleadto a fair value of 90,89$ per share, while the stock market is trading it at 226,11$. Thismeansthatthe stock has apotentialdownside riskto itsfairvalueof-59,8%.

Most analysts come to a more optimistic forecast of future earnings than me. There are two mainreasons for this discrepancy: Sales growth and expenses. As I mentioned earlier, I don’t believe thatthe industry will grow as fast as the overall economy. Regarding expenses, most analysts think thatMcDonald’s can take advantage of thedigitalization. As many of them claim, the number ofemployees can be reduced by using digital terminals and automatization processes. A Germananalystteam publishedthisgraphicinorderto putemphasis on thiseffect.

This graphic shows the growth in revenue per area or m^2. This suggests that McDonald’s can use itsresourcesmoreefficient.

This graphic is flawed and points out the mistakes made by analysts perfectly. McDonald’s startedclosingmanyrestaurants in2014.

I am convinced that McDonald’s has established a very smart business model in a competitiveindustry that allows McDonald’s to earnextraordinarilyhigh profit margin due to its moats, namely itsbrand.Furthermore, thebusinessmodelseemsto beantifragilein the current Covid19 crisisbecause it increases McDonald’s market share. On the one hand, many small competitors in therestaurant industry face bankruptcy threats and on the other hand, McDonald’s drive-thru anddelivery service areabeaconofstabilityinatimeof social distancing andlocallockdowns.

Although its business strategy is profitable, the number of visitors is constantly declining and there islittle to no chance that this trend will reverse in future because McDonald’s has already reached itsproductlifecycle pike.

The increases in earnings in the past years are only an illusion and give investors a false sense ofsecurity.In reality, earningsfrom the operating business are declining. Only in the balance sheets,they are rising through special effects, like the re-franchising process or the U.S. tax reform. Sincethese effects will not occur in the future a second time, investors need to be aware that risingearnings(afterinflation) are unlikely.

I consider the management as not capable to create long term value for the shareholders. Themanagement bought back its own shares when the share pricewereabove its fair value, whichdestroyed shareholder value. Furthermore, they took on debt to do this progress and messed uptheir balance sheet. The high amount of debt and the lack of equity make the company prone to arecession or other risks. Although they own valuable real assets objects, these objects are illiquid andcannotbesold fasttofollowtheirshorttermliabilities.

Iam sure thatthechangesinthe industrywilloccur,for examplemoredigitalizationororedelivery

services. However, I doubt that McDonald’s will maintain their Number One status in this industrybecause entry barriers are low for disruptors (for example Starbucks) and McDonald’s financialsituationdoesnotallowtoheavilyinvestinginfuturetechnology.

A poor financial situation, bad management, high risks of new entrants and declining customers’popularitymakeMcDonald’s a risky investment.

However, the current stock price does not reflect these risks in any way and is significantlyovervalued.Therefore,myrecommendationis: Neverbuyitandneversell ashort!