Finance Analysis of McDonalds - Essay Example

Financial Analysis of McDonalds Financial Analysis of McDonalds Adnan Maachou Please put here This report is a Financial Analysis of McDonalds. The latest balance sheets and other financial statement have been observed and the calculation with regard to the company's profitability position, liquidity position and asset management position has been calculated. Comments are accompanies for each and every calculation that has been performed. In the introduction part of the report, an overview about the business of the company, its evolution, organization structure etc, have been described. All the calculations performed are supported by graphical representations apart from the comments in order to give a clearer picture about the company's financial performance and management efficiency. The capital structure of the company is also discussed as part of the report. COMPANY OVERVIEW A. Brief description about the company: McDonald's is the largest food service company in the world. The company regards itself as the leading global food service retailer. With more than 30,000 restaurants serving more than 47 million people each day in 121 countries it is hard to argue! In 1974 McDonald's opened its first restaurant in the UK. As of 31 December 2001, McDonald's and its franchisees operated over 1,184 restaurants in the UK1 (biz/ed, 1996-2008). B. Company History: McDonald's originated in California, USA. In 1954, Ray Kroc became a franchisee of the McDonald brothers (Dick and Mac) and began opening new restaurants, buying all the rights to the McDonald's concept in 1961 for $2.7 million2 (biz/ed, 1996 - 2008). As of today, more than 2.5 million people of the entire UK population trust the day-to-day operations of McDonalds and also the high standard quality of service and the value for the money spent by them3 (McDonalds). C. Organizational Structure: McDonald's are structured along functional lines. Their Chief Executive oversees five major areas of activity4 (biz/ed, 1996 - 2008): Operations (equipment and franchising) Development (property and construction) Finance (supply chain and new product development) Marketing (sales marketing) Human Resources (customer services, personnel, hygiene and safety) D. Main products and services: McDonald's menu concentrates on five main ingredients: beef, chicken, bread, potatoes and milk, which account for 255 million of food expenditure. The company's main menu lists its basic food offering: the Big Mac, which still exists as a major seller; other standard product names come from the McDonald's convention of adding a 'Mc' to a particular item. So, a chicken sandwich becomes a 'McChicken' sandwich and chicken nuggets become chicken 'McNuggets'. This idea has been extended to their dessert range, with the creation of the 'McFlurry' ice cream5 (biz/ed, 1996-2008). E. Geographic area of operations: McDonald's is one of only a handful of brands that command instant recognition in virtually every country of the world. McDonald's began with one restaurant in the US in 1955 and today there are more than 26,500 restaurants in over 119 countries, serving around 39 million people every day - making McDonald's by far the largest food service company in the world6 (McDonalds). The business is managed as distinct geographic segments: United States; Europe; Asia/Pacific, Middle East and Africa (APMEA); Latin America; and Canada. In addition, throughout this report we present a segment entitled "Corporate& Other" that includes corporate activities and non-McDonald's brands (e.g., Boston Market). The U.S. and Europe segments each account for approximately 35% of total revenues. France, Germany and the United Kingdom (U.K.), collectively, account for approximately 60% of Europe's revenues; and Australia, China and Japan (a 50%-owned affiliate accounted for under the equity method), collectively, account for nearly 50% of APMEA's revenues. These six markets along with the U.S. and Canada are referred to as "major markets" throughout this report and comprise approximately 70% of total revenues7 (U.S. Securities and Exchange Board, 2002). F. Recent developments: Extra Value Meals and Happy Meals are two of the most successful innovations of McDonalds (Brand Republic, 2002). Extra Value Meals offer customers a hamburger, drink and fries sold together at a fixed money-saving price. Similarly, McDonald's Happy Meal boxes offer parents a simple and appealing package, with a smaller portioned meal served in a fun box with a toy. The reason behind the continued success of the family business of McDonalds is these innovations being instrumental. There also occurred many developments organizationally in order to provide its customer a more appealing range of products. For example, the McCafe concept in 1999 was adopted as a mainstream initiative for McDonald's and in 2001 the New Tastes Menu was introduced throughout Australia. These initiatives were developed to reinvigorate the McDonald's brand8 (Owen Wright, 2007). FINANCIAL ANALYSIS a. Sales and Income Record: Fiscal Years 2001 2002 2003 2004 2005 2006 Sales ($) 14,738 15,201 16,825 18,594 19,832 21,586 % change in sales (each yr) 4 3.14 10.6 10.5 6.65 8.84 Net Income ($) 1,637 894 1,471 2,279 2,602 3,544 % change in net income (each yr) 69 -45 65 54 14 36 9 Graph Of Sales & Net Income, FY 2001- 2006 Comments on the above financial figures: In 2006, the Company's increased relevance contributed to more customers visiting McDonald's restaurants, helping drive global comparable sales up 8.8% and extending the company's consecutive monthly increases to 44 months through December 2006. McDonalds' buys a 33% stake in UK-based sandwich chain Prt Manger and this joint venture of the company with UK-based sandwich chain lasted only for two years10 (Caterer Serach, 2006). Probably because of this venture, McDonalds' experienced sluggish sales in the year 2002. The dip is clearly visible as there is negative figure showing the percentage change in the net income of the company for the year 2002. Despite this dip, the company's sales picked up in immediate year and surprisingly the comparable sales of the company increased 6.7% building on a 3.9% increase in the year 2005. Also, System wide sales of the company increased 7% both as reported and in constant currencies and there has been an increase of 9% in consolidated revenues. From the above figures, it is very clear that the company's efforts have increased the consumer relevance and is helping the company in continuously delivered strong results in each year with revenue growth, operating income growth and returns on incremental invested capital. b. Expense Distribution Major Expenses FY 2006 OPERATING COSTS AND EXPENSES Company-operated restaurant expenses Food & paper 5,349.7 Payroll & employee benefits 4,185.4 Occupancy & other operating expenses 4,006.6 Franchised restaurants-occupancy expenses 1,060.4 Selling, general & administrative expenses 2,337.9 Impairment and other charges (credits), net 134.2 Other operating expense, net 67.1 Total operating costs and expenses 17,141.3 CHART OF EXPENSES, FY 2006 Comments: From the above expense distribution statements, it is very clear that the company has distributed the maximum amount of money over payroll and benefits of its employees after food & paper. This clearly states that the company is taking every measure for the benefits of its employees and also this states that the company believes in the strength of its employees. c. Assets and Capital Structure: Assets FY 2006 Buildings 21,682 Land/Improvements 4,723 Machinery/Equipment 4,840 Other Property/Plant/Equipment 566 Property/Plant/Equipment - Gross 31,810 Property/Plant/Equipment - Net 20,846 Goodwill, Net 2,209 Long Term Investments 1,036 Other Long Term Assets 1,307 Total Assets 29,024 CHART OF ASSETS, FY 2006 Comments on the company's Asset distribution: The McDonald's total assets include a portfolio of over 3000 McDonald's sites where the real estate is leased, rather than owned. Lease option exercises and purchase option exercises, negotiated purchases, negotiated lease extensions, and terminations and all similar issues are handled by the company's asset management team. They handle special situations that arise with leased property. Capital Structure FY 2006 Total Current Liabilities 3,008 Other long-term liabilities 1,074.9 Common Stock 17 Preferred Stock 0 CAPITAL STRUCTURE, FY 2006 Comments on the company's Capital Structure: Capital Structure of McDonalds is highly concentrated upon increasing the values of its shareholders. The company, with an intention to maximize shareholder values, continuously strives to find out the best ways of capital deployment and also focuses its efforts on driving higher returns by running great restaurants. d. Ratio Analysis: Ratios are well known and the most widely used tools of financial analysis. A ratio gives the mathematical relationship between one variable and another. The analysis of a ration can disclose relationships as well as bases of comparison that reveal conditions and trends that cannot be detected by going through the individual components of the ratio. (1) LIQUIDITY: Liquidity implies a firm's ability to pay debts in the short run. This ability can be measured by the use of liquidity rations. Short - term liquidity involves the relationship between current assets and current liabilities. If a firm has sufficient net working capital it is assumed to have enough liquidity (ICFAI Center for Management Research ICMR, 2004). Current Ratio: Company11 1.45 1.21 Industry Average 0.4 0.98 Quick Ratio: Company 1.25 1.01 Industry Average 0.4 0.74 COMMENTS: In the operating cycle of the firm current assets are converted into cash to provide funds for the payment of current liabilities. Hence, if the current ratio is higher it means that the short-term liquidity of the firm is also higher. McDonald's ratings continue to incorporate its leading position in the global quick service restaurant industry, exceptional brand awareness, extensive real estate holdings, franchise income and broad geographic diversity. (2) ASSET MANAGEMENT: This ratio falls under the category of Efficiency ratios. These measure the efficiency of the firm's activities and its ability generate profits. Total Asset Turnover: This highlights the amount of assets that the firm used to produce the total sales. The ability to produce a large volume of sales on a small asset base is an important part of the firm's profit picture. FY 2005 FY 2006 Company 0.71 0.73 Industry Average 1.06 1.18 Average Collection Period: it is possible to sense of the speed of collections from receivables turnover ratio and it is valuable for comparison purposes, but it is not possible to directly compare to the terms of trade that the firm usually gives. The ratio, which gives the above comparison, is average collection period. Average collection period is one, which is defined as the number of days it takes to collect accounts receivable. FY 2005 FY 2006 Company NA NA Industry Average 8.46 10.70 COMMENTS: The total asset turnover of McDonalds is quite healthy both in terms of absolute and also in comparison with the industry as the turnover of industry is only 1.06. Most stocks in the restaurants industry have seen steadily growing revenue and impressive earnings growth over the past three years. The stocks of McDonalds has seen steady revenue growth over the past three years. Like its peers, this stock's earnings per share have grown at a very high rate over past three years, though they actually declined last year. Note that this stock's sustainable growth rate is quite a bit less than the rate at which its earnings per share have grown. That means that the company will probably have to raise additional capital from outside sources at some point if it continues to grow at its current rate. (3) DEBT MANAGEMENT: This is one of the leverage ratios. When the analysis of a firm is extended to the long-term solvency, we come into the category of leverage ratios. The leverage ratios are structural ratios and coverage ratios. Structural ratios are based on the proportions are derived from the relationships between debt servicing commitments and sources of funds for meeting these obligations. Total Debt to Total Assets: This ratio measures the extent to which borrowed funds support the firm's assets. The denominator in the ratio is total of all assets as indicated in the balance sheet. The type of assets an organization employs in its operations should determine to some extent the sources of funds used to finance them. FY 2005 FY 2006 Company 0.59 0.54 Industry Average 0.68 0.93 Times Interest Earned: Company 18.1 19.3 Industry Average ____ 8.89 COMMENTS: As indicated above, McDonald's Debt-Asset Ratio is 0.59 for the year 2006 and 0.54 in the year 2006 which implies that 59% of the total assets are financed from debt sources for the year 2005 and similarly 54% of the firm's total assets are financed from debt sources. When these figures are compared with the industry average debt-asset ration of 0.68 and 0.93 for the respective years of 2005 and 2006, it is clear that McDonalds is having a lower leverage compared to the industry. (4) PROFITABILITY: These ratios are also called as the Efficiency ratios. As described above they measure the firm's activities and its ability to generate profits. Net profit Margin: This ratio shows the earnings left for shareholders (both equity and preference) as a percentage of net sales. It measures the overall efficiency of production, administration, selling, financing, pricing, and tax management. FY 2005 FY 2006 Company 12.72 16.42 Industry Average 7.26 7.97 Return on Assets: Company 0.71 0.73 Industry Average 8.12 8.46 Return on Equity: Company 17.73 23.16 Industry Average 21.78 21.47 COMMENTS ON THE COMPANY'S PROFITABILITY: Most companies in the restaurants industry have generated very low returns on assets over the past five years. McDonalds has posted results that are about average for its industry. Return on Equity for the industry is 21.78 for 2005 and 21.47 in 2006. When this is compared with the company figures, it is clear that McDonalds has given 23.16% return to the equity holders in the year 2006 which is higher when compared to the industry figures though the company's figures were less in the previous year. Thus, it can be concluded that McDonalds has employed its resources productively. (5) MARKET VALUE RATIOS: From the Market Value Ratios, we can get information on earnings of the firm and their effect on price of common stock. PE Ratio: The price-earnings ratio gives the relationship between the market price of the stock and its earnings by revealing how earnings affect the market price of the firm's stock. FY 2005 FY 2006 Company 19.3 39.5 Industry Average 29.65 25.9 Market to Book Ratio: Company 3.6 4.7 Industry Average 4.6 5.73 COMMENTS ON THE COMPANY'S MARKET VALUE RATIOS: McDonalds has generated market-like returns over the past 5- and 10-year periods. McDonalds has been one of the strongest performers in its industry over the five-year period. The company has got relatively large number of competitors, and looking at its sales, it is one of the largest players. CONCLUSIONSAND RECOMMENDATIONS McDonalds, as everyone knows, is one of the world's largest food chain and a key player in the restaurant industry. The company regards itself as the leading global food service retailer. The company has got over 30,000 restaurants all across the globe and is serving more than 47 million people in almost 121 countries each day. As part of this paper, the financial analysis of McDonalds has been carried out. The various financial aspects like the company's sales and net profit, asset and capital structure, expense distribution have been observed and analysed for a period starting from 2001 to 2006. Each of the above discussed calculation and analysis have been supported by a graphical representation. The overall performance of the company with respect to all these various calculations was very good except that there had been a dip in the overall sales of the company in the year 2002 which was eventually made up in the very next year. Also, ratio analysis of the firm has been done from different perspectives like liquidity, profitability, asset turnover, efficiency and market valuation etc, for two consecutive years i.e. 2005 and 2006. An important and yet notable figure with respect to the market valuation of the company is its price-earnings ration which actually exceeded the industry average in the year 2006 which clearly shows the efficiency of the firm in productive utilization of its resources. Thus, the entire financial analysis of McDonalds clearly shows that the company's performance in comparison to the industry is pretty good. Bibliography 1. (ICMR), I. C. (2003). Financial Management for Managers. Hyderabad: ICFAI Center for Management Research . 2. (ICMR), I. C. (2003). Operations Management. Hyderabad: ICFAI Center for Management Research (ICMR). 3. Answers.com. (n.d.). Answers.com Library. Retrieved 01 31, 2008, from Answers.com: http://www.answers.com/topic/educationcat=health 4. Bank, B. 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