McDonald's dominates the global quick-service restaurant landscape. Although there are more Subway franchise units in the U.S., and Yum Brands has the largest number of restaurants across the globe, McDonald's maintains a sizable system sales lead. McDonald's generated $88 billion in sales at its company-owned and franchised restaurants during 2012 (roughly 4% of the $2.1 trillion global restaurant industry), doubling Yum Brands' $44 billion and dwarfing Subway's $12 billion. This comes out to more than $2.6 million per McDonald's restaurant, making the locations the most productive among publicly traded quick-service restaurant operators.
With an extremely strong brand, a cohesive franchisee system, tremendous scale advantages, and leading share in virtually every country in which it operates, McDonald's has the widest economic moat in the restaurant industry, in our opinion.
|Economic Moat||Fair value||Stewardship Rating|
KEY INVESTMENT CONSIDERATIONS
- Trading at 17 times forward earnings and 11 times forward EBITDA, shares are modestly undervalued to our new fair value estimate of $105.
- While we believe McDonald's will fall just short of its 6%-7% operating income growth target in 2013 amid value menu marketing efforts and ongoing modernization efforts, we view these efforts as tactical measures to protect its share of industry traffic and enhance its competitive positioning.
- We view McDonald's as suitable for investors looking for exposure to an expanding global middle class, but wanting to build more defensive positions. McDonald's dividend currently yields about 3%.
- McDonald's maintains the leading market position in virtually every country in which it operates with the exception of China, and global expansion opportunities still exist.
- Widespread restaurant exterior and interior reimaging efforts, engaging marketing campaigns, extended hours, free wireless Internet access have reinvigorated the brand and elevated the customer experience, helping to preserve restaurant traffic.
- Premium products such as the Angus Third Pounder hamburger and the McCafe specialty coffee menu have been well received the past few years. We're also optimistic about an expanded U.S. launch of the McWrap (a larger variation of the successful snack wrap product), new breakfast test products (including the Egg White Delight McMuffin and Steak and Egg Burrito), and new beef sandwich, chicken entree, and beverage product launches later in 2013.
- McDonald's produces stable cash flow, even in challenging economic times, because of long-term franchisee royalty and rent payments. The firm owned 45% of the land and about 70% of the buildings for its restaurants at year-end 2012.
- McDonald's has a 30-year-plus history of paying cash dividends and repurchasing shares, including $5.5 billion returned to shareholders in 2012.
- The quick-service restaurant industry is fiercely competitive, marked by a history of price wars. Switching costs are virtually nonexistent.
- Volatile commodity costs, foreign currency headwinds, and difficult year-over-year comparisons could disrupt McDonald's short-term results.
- Bankruptcies among quick-service franchisees increased during the recession. High food, energy, and labor costs are a concern, and tighter credit markets could constrain growth among small franchisees.
- Many rivals, including Burger King, Jack in the Box, and CKE Restaurants, aggressively target frequent fast-food eaters with indulgent items. However, as the largest player in the industry, McDonald's often receives the blame for rising obesity problems.
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