Is McDonald's Stock A Buy? MCD Deep Dive

Hi, I'm Jimmy. In this video, we're looking at McDonald's, ticker symbol MCD. So, in this video, we're going to go through the basics of McDonald's business, run through some of the numbers, and then we're going to try to come up with a fair value for McDonald's stock to see if it's worth investing in today. Okay, so let's jump in and look at how this company breaks up their business. So, we have franchise revenue and company operated restaurants. Now, interestingly, they have significantly more restaurants. We'll look at some of the numbers in a second, but they have significantly more franchises than they do have company operated restaurants. But I just want to point out that from a revenue perspective, it's about 2/3 a third. That becomes important in a second, but to me, I think it's very important that we understand kind of the basics of how this business works. And well, this will be more important as we look at some of the criticisms I have of McDonald's as a fundamental business recently. So really, there's two key levers that make this business grow. First is customer traffic. How many customers come into the restaurants? And second, what is the average spend of those customers? It's really that simple. Now, obviously, we can multiply that by the number of restaurants that they have. follow along for a second because it's interesting how these numbers are all tied together because McDonald's has some interesting ways of reporting their numbers. So, first we could see how many locations they have and the vast majority of those restaurants are franchised locations. Now one interesting point here if you look at this chart this you know going back the past 20 or so years you can see that there was sort of a hop up in let's say the an increase in the velocity of restaurants opening up and that happened right around the 2017 region. Now, that's important because now when we jump over and look at a chart for companyowned restaurants here, we can see that around 2017, McDonald's made a decision to drastically decrease the number of company-owned restaurants. Now, it dropped from about 6,000 to about 2,000 now, give or take, but we could see that that happened right around 2017. So, in fiscal 2025, we're talking about 2,000 company owned restaurants and about 43,000 franchises. That's important again because I just want to point out the disparity. Going back real quick, just back to this chart here. Look at the revenue split up. The company owned restaurants significantly increase the total amount of revenue that McDonald's generates. Again, we're going to come back to this in a second, but for now, let's look quickly at how franchises in order to understand how the numbers are really affected. It's important that we understand how franchises pay McDonald's basically. I think that's the most important way to look at this. So, first we got a franchise fee. Typically about 4 to 5%. I believe the most recent numbers are about 5%. But, you know, some restaurants were already grandfathered in. If you're a new restaurant owner, there's actually an upfront franchise fee you got to pay. Uh, I'm just talking about the recurring one on an annual basis, 4 to 5% of revenue. Now, many of the locations that McDonald's has, either McDonald's owns the restaurant or owns the land or the building, and then they rent it out to the franchisee. In some cases, they lease it and then they in turn rent it out. Doesn't happen in all situations, but that is largely a part of their model. That's probably a good thing from an asset perspective. if they got a whole bunch of land and things like that in decent locations, but typically rent is tied to revenue as well. So, let's say rent is about from what the estimates I've read are somewhere between 9 and 11% of total revenue. So, if the company earns, you know, a million dollars this year, maybe rent next year, be about $100,000 on an annual basis. And then sometimes there's some other fees tied into it. Technology fees, upgrade fees, marketing fees. Some of those McDonald's cover, some of them the franchises have to cover. So it's it's more complex than I'm making it sound, but I'm just giving us a broad understanding of how McDonald's is getting paid. The most important takeaway from this slide is that McDonald's is getting paid based on the revenue that the restaurant does. And this brings us to a chart of systemwide revenue. This chart goes back to 2008. blue bars actual numbers, green bars analyst estimates. And we can see here that in the last fiscal year, McDonald's put up about $140 billion systemwide revenue. And then analysts have that projected to go higher. But just so we're on the same page, systemwide revenue is the total revenue that all the McDonald's locations are generating. So, if there's a franchisee that generates a million dollars, $1 million lands in systemwide revenue, but it's not actually it doesn't all belong to McDonald's. McDonald's only got a cut. In that case, maybe $150,000 out of the million dollar goes to MC McDonald's as the main company and the franchisee has to pay McDonald's $150,000. So technically, McDonald's only counts the $150,000 from the franchises as revenue. Systemwide revenue is simply a way for us to see how much all McDonald's are generating from a revenue perspective. But when we look over, if you ever look at if you're on the investors go website and you look at McDonald's revenue, this is an ex exact chart of McDonald's revenue going back the past 20 or so years. And we can see that this chart looks drastically different than the systemwide revenue we just saw. Now, obviously, the bottom of this chart is 2020. And we're going to ignore 2020 for very hopefully very obvious reasons why 2020 would be the bottom. But if you ignore that, if we remove that from this in the most recent bottom, I suppose the beginning of the chart was really at the bottom, but the most recent bottom, ignoring 2020, was right around the 2017 area. What happened in 2017? Well, that's when McDonald's shifted away from the restaurants that they controlled. So, revenue was climbing much higher. If they decided that they were going to have all of their revenue, all of the restaurants were going to be company-owned and operated. Well, of course, the revenue would be significantly higher. We already saw what that system revenue looks like. That would be significantly higher. But once they shifted away and they cut their company own restaurants from about 6,000 out of 2,000, well obviously that has a meaningful impact on their total revenue. That led me when I was doing the research that led me to try to get a better understanding of why make that shift, why put yourself in a position where you're kind of kind of going to reset revenue and you got to build it back up. And one of the p primary reasons at least if we go back and look at what McDonald's had said at the time when they shifted away from that model was to try to improve profit margins. And we can see that operating profit margins have in fact inched higher over the past couple decades. Now this is important to remember from a how the business works perspective. So think about McDonald's the broader company and then you have the franchisee owner. have the franchise owners underneath that frankly they get stuck with most of the bills. So going back to what we said before rent is tied to revenue. Rent is tied or or the fran the franchise fee is tied to revenue. They're not tied to profit. So if expenses go up a bit, for example, the ex the cost of beef were to go up or the co the minimum wage for employees, whatever their average salary is for McDonald's employees, if that goes up, it's the franchise, it's the franchise owners that have to pay those increases. If they generated a million dollars in revenue, which by the way would be kind of a low number for many McDonald's locations, but if they generated a million dollars in revenue, they're paying $100,000 in rent. Just to take roundabout numbers, $100,000 in rent, $50,000 franchise fee. No matter what happens, $150,000 right off the top. Cost of food, cost of labor, all of that stuff, all the electricity, all that stuff. If those costs go up, well, that comes directly out of profit. But from McDonald's perspective, it's a little cleaner. They get the $150,000 and they don't have to deal with the increase in cost. They don't have to deal with the increase in labor expenses and all that stuff. So ultimately, you can be left with net income profit margins that are increasing over the past few years. That was exactly the reason that McDonald's did it. Now, when we get to the fair value section, I'll share my personal opinion with some of my criticisms of McDonald's and how they got here, but we'll come back to that in a second. For now, let's finish off some of the numbers by looking at earnings per share. Earnings per share have consistently climbed up over the past few years. Now, one semi- big criticism I have for them is their debt. Debt, the orange bars here have increased a decent amount. Compare that. This is uh short long-term debt compared to cash. Short-term investments, long-term investments, the purple bars. Cash is down very low, whereas debt has increased a decent amount. We're going to come back to this in a second when we start looking at discounted free cash flow. But before we do that, let's jump and look at the fair value for McDonald's stock. So, I've got a few different fair valuation methods to consider because they all give us an interesting piece of the story. First is price to earnings. So when we look at McDonald's price to earnings chart over their own history, well right now it looks like it's on the lower end. So at about 21x, this could be an interesting place to consider buying it. When I first looked at this, I was like, "Oh, okay. This looks like, you know, it's slightly undervalued. I'd say it looks like a decent buy right here." But then I jumped over and looked at the fair value multiple uh discount of free cash flow is what I meant to say that I then I looked at discounted free cash flow for McDonald's stock. And here's where we run into some issues. So first green bars are analyst estimates. Now on the investors grow website if you mouse over the individual bars you can see how many analysts are recommending uh like how many analysts what was the average it's the average number of how many analysts in the 2028 number which is the third year well there was actually 10 analysts and then when you see that bigger jump I think part of that is due to the fact that we drop down in the number of analysts that give us analyst estimates goes from 10 analysts to four analysts but in our case even with if anything I would say that's slightly more optimistic number. And even with that more optimistic number, the stock still looks reasonably undervalued. Now, I'm only using a required rate of return of 9%. Slight premium over AAA corporate bonds, which is how I got that number. So, while this company looks 40% overvalued, now if we used a higher required rate of return, it would be even more overvalued. Now on the investors grow website we actually have this box here where you could check you can click on to look at what the CAPM fair value is. So you can see up here that the CAPM number actually comes in at 6.52%. 6.52% is frankly quite low and if we're using 6.52% then yeah the stock looks a bit undervalued right now. But to me this actually brings up an interesting point. One of the reasons that capital asset pricing model, which is what CAPM stands for, by the way, I did a video on CAPM if you're curious. I'll leave a link in in the description below to that video if you're curious what CAPM is and how to come up with the number. But one consideration with how you get CAM is the more volatile the stock, the higher the beta of the stock, the more the stock moves around relative to something like the S&P 500, the higher CAPM would be. though in theory a lower CAPM number this is a fairly low number it would make sense that a company like McDonald's would be there because if we're going into McDonald's let's call spade a spade if we're investing in McDonald's odds are we are not doing it for the obscene growth that they're having it we're doing it as more of a defensive play maybe perhaps something to diversify our portfolio and if that's the case well perhaps this could be an interesting valuation method to use or an interesting company to consider Now to kind of support this thought process, I actually also included price to free cash flow. Now I was curious about price to free cash flow because initially as you guys saw when we looked at discounted free cash flow it looked about 40% overvalued. So I flipped over price to key free cash flow to see how historically the the stock was valued relative to its own free cash flow. And we can see that right now it does in fact look like it's a bit undervalued. So when looking at price to free cash flow or price to earnings or even discounted free cash flow when using their own capital asset pricing model as a required rate of return, the stock looks like it could be undervalued and the stock has pulled back a decent amount over the past year. So perhaps this is an interesting opportunity. Now, one of my broader criticisms of this company is I don't know if you guys have noticed, but I've been to McDonald's. I'm actually a huge fan of McDonald's. I've got like the the palette of a 10-year-old. I love McDonald's and I love that type of food, but it has gotten really expensive. I mean, relative to other burger places or relative to a lot of other things, it seems like McDonald's has gotten outsized, you know, not outsized, uh, superersized. Uh, it got like excessively o overpriced relative to other options. Now, I actually dug into some of the numbers and looked at like the price of the Big Mac compared to now, compared to like five or six years ago, and it actually hasn't been the prices haven't gone up as much as some other location like other restaurant types or even more than the broader inflation. In some cases, it has, but broadly speaking, not as much as I originally thought. The feeling I had was that it was super overpriced, but it turns out it's not as bad as I thought. [snorts] But again, considering the, you know, I thought McDonald's was supposed to be like a quick and decent food tastewise. Uh maybe not health-wise, but you know what I mean. I thought I thought it was fast food. It was supposed to be that way. It was supposed to be cheaper. And to me, it doesn't really seem like that as much anymore. Now, I live in the New York, New Jersey area, so perhaps it's different here than where it is in your location. I'm curious what you guys think about that. Let me know in the comments below. But either way, I think McDonald's is interesting, but I think that they're fighting a lot of issues. Their need to upgrade their the rising costs, the rising employee costs. I think all of this is going to put pressure on their franchise. All the franchise owners, I think, are going to feel a lot of that pressure. And I think that could put some growth pressure on the broader company in general. Now, I do think that they they're do decent, but I'd have to see a frankly a much bigger pullback. If this stock was trading right now, PE ratio is about 21x. If it was trading below 20, maybe that would be a bit more interesting. I'd like to see a bit more of a pullback before I personally consider jumping in and buying this one. Although, it's borderline for me. But, let me know what you think in the comments below. And if you want to sign up to get access to the Investors Grow website where we try to make it quick and easy to analyze companies, I'll leave a link right here, link in the description below. Thank you so much for stick with me all the way to the end of the video. I really do appreciate it. Thank you and I'll see you in the next video.