Understanding McDonald's: Comprehensive company primer and profitability analysis (Part 10 of 21)
The Market Realist team identified relevant comps for McDonald’s, of which Burger King (BKC), Wendy’s (WEN), Yum! Brands (YUM), Popeye’s (AFCE), and Chipotle (CMG) made the top of the list. Given the size and scale of McDonald’s, it was difficult to include additional companies in this analysis.
From the comparables table above, it’s clear that McDonald’s is a leader from a market share perspective. However, the company suffers from a lower valuation on both an EV/EBITDA basis and a P/E basis. The reason for this is most probably a lack of EBITDA and earnings growth, which we discussed in the earnings snapshot earlier in this series. Due to the mature nature of the business, though, it has a higher free cash flow yield than its peers, at 4.32%. It also has a much higher dividend yield of 3.23%, making it part of an elite group of Dow and S&P 500 companies in the United States called the “dividend aristocrats.”
Also on the list, Burger King has a much higher valuation, at 14.2x forward EBITDA versus 10.3x forward EBITDA for McDonald’s. Chipotle has the highest valuation, at a whopping 22.1x forward EBITDA. On a forward P/E basis, both Wendy’s and Chipotle rank at the top.
Broader competitive dynamics
On a broader basis, McDonald’s restaurants compete with international, national, regional, and local food product retailers. The company competes on the basis of price, convenience, service, menu variety, and product quality in a highly fragmented global restaurant industry. The company’s primary competition, which management refers to as the “informal eating out (IEO) segment,” includes the following restaurant categories defined by Euromonitor International.
- Quick-service eating establishments
- Casual dining full-service restaurants
- 100% home delivery or takeaway providers
- Street stalls or kiosks
- Specialist coffee shops
- Juice or smoothie bars
- Self-service cafeterias
The IEO segment excludes establishments that primarily serve alcohol and full-service restaurants other than casual dining.
Based on data from Euromonitor International, the global IEO segment was composed of approximately 7.0 million outlets and generated $1.05 trillion in annual sales in 2011, the most recent year for which data is available. McDonald’s companywide 2011 restaurant business accounted for approximately 0.5% of those outlets and about 8% of the sales.
Management also on occasion benchmarks McDonald’s against the entire restaurant industry, including the IEO segment defined above and all other full-service restaurants. Based on data from Euromonitor International, the restaurant industry was composed of approximately 14.8 million outlets and generated about $2.11 trillion in annual sales in 2011. McDonald’s companywide restaurant business accounted for approximately 0.2% of those outlets and about 4% of the sales. On a broader basis, we could include Starbucks Corporation, Yum! Brands, Burger King, Panera Bread, Wendy’s, Chipotle Mexican Grill, Whitbread, Darden Restaurant, Tim Horton’s., and Bloomin’ Brands as McDonald’s competitors.
Porter’s Five Forces
The barriers for entry are low for the fast food industry. This means that a new competitor is always on the horizon. Consumers make their purchasing decisions based on price and convenience, meaning the buyer has purchasing power. Suppliers also have bargaining power. With the higher energy and oil prices, commodities like corn and wheat have undergone price increases as well. These higher commodity prices have reduced the profit margins of the entire fast food industry. Another problem is that with the intense price-driven competition, McDonald’s can’t push these margin losses back onto the consumer. The company must absorb the hit because of the high number of substitutes available.
Browse this series on Market Realist:
- Part 1 - McDonald’s global business model, the “three-legged stool”
- Part 2 - What is a franchise and how do McDonald’s franchise agreements work?
- Part 3 - How important are franchise revenues to McDonald’s?
- Consumer Discretionary
- Burger King
- Euromonitor International