Monika Kotecha is the chief investment officer at Insync Funds Management.
What is your professional pick?
Our focus is on investing in exceptional businesses which deliver consistently high returns on capital, strong cash flow generation and look after shareholders in the form of growing dividends and/or share buybacks.
McDonald’s Corporation franchises and operates McDonald’s quick-service restaurants (QSR). Founded in 1948, the company currently has more than 36,000 locations in more than 100 countries. More than 80% of McDonald’s restaurants worldwide are franchised, and approximately 60% of the units are located outside the U.S.
The company is well diversified geographically generating approximately 44% of profits in the U.S., 41% in Europe and 15% primarily in Asia.
How long have you held the stock?
We have held McDonald’s for 8 months. Prior to the purchase the stock has not performed as well as the market. The company had a period of slower growth with disappointing operational performance over the last three years. Growth in the top line had decelerated leading to generally negative sentiment on the stock.
We had been following the company for a number of years and in our experience most companies at some point in time experience a temporary slowdown in their business which the market often views as a structural problem which provides an attractive entry point. The change in management we believe will be a key driver of positive change.
What do you like about it?
McDonald’s has a number of characteristics we look for in a great business. Firstly it has a high level of recurring earnings with 75% of operating profits derived by royalties and rent which provides stability in earnings. The company’s focus on value in the food sector provides the business with a high degree of resilience through the economic cycles with positive EPS growth throughout the last recession.
How is it better than its competitors?
No other QSR chain has the company-level financial resources of McDonald’s, as McDonald’s generates greater than 10 times the operating profit of QSR (Burger King/Tim Horton’s), greater than thirty times Wendy’s and greater than three times YUM Brands. Despite recent stumbles McDonald’s remains around 3-6 times larger than each of its major rivals domestically, and with around US$2.6m sales/store MCD is by far the industry volume leader as well. McDonald’s industry-leading advertising budget and product development resources are a significant advantage versus its peers.
What do you like about its management?
Steve Easterbrook, who was previously the senior executive brand president and chief brand officer at McDonald’s, replaced Don Thompson as chief executive in January of this year and in our opinion is a key catalyst. Easterbrook is McDonald’s first British CEO. In 1993 he joined McDonald’s as a financial reporting manager in London. He spent 18 months at “Hamburger University,” McDonald’s corporate training academy near Chicago. He worked in various operational and finance roles before being promoted to vice-president for the UK’s southern region in 2001. In 2006 he became the CEO of the McDonald’s UK, overseeing more than 1,200 outlets. During his time there he was credited with turning around the business in the region, by introducing a sharp focus on employee training, adding healthy options to the menu and implementing a major restaurant redesign.
The early signs of his impact on the whole business appear to be positive with improving SSS (same store sales) trends in their international operations and stabilization in the US.
Where do you see the value?
MCD is undervalued as there is significant operating leverage in the business available through efficiency improvements which will drive greater margins which when combined with improving SSS could lead to significant earnings growth over a number of years which the general market is not appreciating.
What is your target price on the stocks?
We believe that the stock could reach a price in the high $120s over the next 12 months with the potential to go higher if same store sales in the US continues to increase over time.
At what point would you sell it?
We will consider selling once valuations reflect its full potential. At this stage it is in the early stages of turning around the performance. Metrics that we follow include SSS trends, whether the high returns on invested capital is being maintained and does the company continue to reward shareholders with increased dividends and/or share buybacks.
The stock has added value increasing over 13% in the period held.
McDonald’s Corporation (NYSE: MCD)
Source: Yahoo!7 Finance, 19 November 2015
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