McDonalds - Part 3
McDonalds - Part 3
Let's see the story of this burger joint
Last week we valued McDonalds, a fast food company with a distinctly real estate theme.
In that valuation we came to the conclusion that I might have overpaid for the shares I purchased.
Today we’re going to have a look at this companies story. We will be going over the risk factors, its prospects in the near future, and what my next steps regarding it will be.
The Risk Factors
Every company has risks inherent to them and McDonalds is no different.
Fortunately there is an easy way to find them out, we just need to read their annual report.
There’s plenty of risks outlined there, but I’ll outline the ones I find more important:
The COVID-19 pandemic has adversely affected and is expected to continue to adversely affect our financial results, condition and outlook.
If we do not successfully evolve and execute against our business strategies, including the new Accelerating the Arches strategy, we may not be able to drive business growth.
Failure to preserve the value and relevance of our brand could have an adverse impact on our financial results.
We face intense competition in our markets, which could hurt our business.
Increasing regulatory and legal complexity may adversely affect our business and financial results.
Changes in commodity and other operating costs could adversely affect our results of operations.
A decrease in our credit ratings or an increase in our funding costs could adversely affect our profitability.
Each of these risks are fairly self-explanatory, but they can be roughly separated into a few categories:
Operational impacts - Which include Covid-19 related problems, supply chain issues, etc…
Business Strategy impacts - Which include changes in consumer demands, and business expansion and general future-proofing related issues
Legal impacts - Which go from higher taxes to crackdowns on “unhealthy food” like we’ve been seeing throughout the developed world.
Cost of Capital Impacts - Which include the ability to raise capital, either equity or debt based capital.
All of these can be problematic, but I would say most can be addressed by management in some way.
The most concerning to me would be a decrease of credit ratings, which would severely hamstring the companies ability to operate and grow.
As we discussed before, McDonalds has a negative book value, which means that the entirety of the equity of the company could be “called in” to service outstanding debts.
That said, since the vast majority of debt repayments is “matched” with a comparable contracted revenue, I am not concerned with the companies ability to pay their debts in the near future.
At the same time, the fact that no real “debt cliff” exists means that raising interest rates as a result of a credit rating cut would have milder effects.
In terms of the operational issues, there’s been a lot said about commodity prices, wage hikes and inflation. While those are all potential issue, the fact is McDonalds has a highly developed supply chain, and high automation potential which it is now taking advantage of.
Ultimately I think the company can come out of it stronger than traditional restaurants.
In terms of legal impacts I think we are now on a downtrend of health conscious regulation. While I don’t doubt that new “Sin Taxes” are incoming in order to balance states income statement, ultimately I feel like the big driver for “healthy eating” and similar regulation is now on its last legs, and will continue to fade into obscurity in the mid-term.
The big issue is really the ability of the company to continue to execute its strategy, something we will discuss next.
The Near Future Prospects
Accelerating the Arches is a three pillar plan for the companies next phase of sustainable growth:
In other words they are focusing on Marketing, their core products, and in providing better methods to get their products to their customers.
All of this is good, particularly the third part, “D”.
I think that Delivery is something where McDonalds has lagged unnecessarily for quite some time. There is no reason why “Pizza delivery” couldn’t have been changed to “McDonalds Delivery” 20 years ago, so I’m glad that they are finally focusing on this key customer service and sales channel.
The Digital portion is also something that I’m very happy with.
If you’ve been to a McDonalds recently, you will no doubt have seen some of those large digital ordering screens. This is just the most visible portion of the automation that McDonalds can bring into their stores.
While I don’t believe a fully automated kitchen is in the near horizon, there are plenty of places where McDonalds can make use of this digitization.
Ultimately this automation will reduce employee counts, which means reduced wage costs and subsequently higher margins and profits.
It will also provide a shield against claims of exploitation, by reducing the amount of low-valued added employees who will necessarily receive correspondingly low wages.
The Next Steps
Ultimately while I do believe McDonalds has a growth path ahead of them, much like with Pepsico I don’t believe I can justify the current price.
I will not be purchasing anymore McDonalds at current prices.
That said, as to whether I should sell the company…
I’m not sure.
McDonalds is a quality company, which although heavily ladden with debt, is unlikely to fail because of the way that debt is structured, alongside the stability of their business.
As a general rule I don’t like selling quality companies, even ones that aren’t growing fast, because quality companies tend to do well in the long term. At the same time, I don’t want to own companies that are grossly overvalued, I’d prefer to take advantage of Mr. Market and put my money to work somewhere else.
McDonalds is grossly overvalued.
I have not yet decided if I will sell McDonalds, but when I do I will let you know over my Twitter.
What about you? What do you think I should do with McDonalds?
Let me know in the comments down below!
And as always, if you have any questions or comments, shoot them on Twitter @TiagoDias_VC or down below!
I’ll see you next time!