Finance of Competing Fast Food Entities - Case Study Example

Professor

May 9, 2016

Project 2

Introduction

The paper discusses the financial picture of competing fast food entities. One of the entities is Starbucks. The other entity is McDonalds. Although both competitors sell different products, they both compete for the same individuals. One individual may prefer visiting the nearest McDonalds restaurant to take one’s breakfast. On the other hand, other individuals will prefer to take their breakfast at the nearest Starbucks restaurant. People who love the unique coffee blends of Starbucks will often return to take another sip of the patented Starbucks coffee choices (Ang, 2013).

However, other individuals may prefer the unique fast food products of McDonalds. Some will prefer the hamburger or cheeseburger alternatives of the nearest McDonalds branch (Michael, 2011). The children will prefer the caffeine –free beverages offered by the McDonalds branches. Likewise, the children will prefer the play areas of the typical McDonalds fast food chain over the coffee branches of Starbucks. McDonalds and Starbucks serve the unique needs of different market segments.

I: Restaurant Competitors

a. Company Profile

Starbucks.

Starbucks focuses its marketing efforts on selling coffee products (Starbucks, 2016). The entity sells high priced coffee products to a select market segment. The select market segment is composed of individuals who love to sip a cup of coffee (Kumar, 2013). The same entity focuses its marketing efforts on individuals who can pay for the higher priced coffee products. In the same entity’s restaurants, the present and future customers can buy snack items. The snack items can be used to accompany the coffee products.

Further, Starbucks sells its products in restaurants in more than 70 countries. The same entity sells coffee products in all its branches. Consequently, McDonalds cater to the needs of coffee lovers. The countries are strategically located in many parts of the world. The global market segment of Starbucks is divided into sub market segments. The sub market segments include the Americas market segment. Another market segment is Europe. A Third market segment is the Middle East. A fourth market segment is Africa. Another market segment is China or Asia Pacific.

Furthermore, the company offers several snack items. The most popular item is coffee. The second most popular item sold in the Starbucks branches is the tea products. The entity sells roasted beans. The same entity sells ground coffee as well as ready to-serve coffee. The company sells other snack products. The products include pastry choices. The company headquarters is in Seattle (Washington). The founders of the company opened the business during 1985 (McDonalds, 2016).

McDonalds.

The McDonalds Company’s headquarters is in Oak Brook, Illinois. The company sells fast food items. The popular products of McDonalds include the famous hamburger and cheeseburger alternatives. The McDonalds branches are strategically located in many countries around the world. The global market segments of McDonalds are divided into several sub market segments. One of the segments is the United States market segment. Another market segment is Europe market segment. A third market segment is the Asia/Pacific market segment. A third market segment is the Middle East. A fourth market segment is the Africa. A fifth market segment is the Canada market segment. Another big market segment is the Latin America market segment (McDonalds, 2016).

Further, the company offers franchise contracts to individuals or entities in any part of the world. Under the franchise agreement, the partners will use and sell the McDonalds name. With the proven popularity and quality of the McDonalds products, the newly established franchise branch can easily generate higher customer visits compared to setting up an unknown new fast food chain or restaurant (McDonalds, 2016).

b. Corporate (Governance) CEO

Starbucks

Howard Schultz , 63 yrs old is the Chief (Executive) Officers of Starbucks Company. His salary is estimated at $90.3 million per year. He started in Starbucks with the Seattle Branch during 1982 as director of business operations and marketing activities. The branch location is Pike (Place) Market. His love for Italian coffee persuaded him to focus his business activities within the Starbucks restaurant business. The Starbucks board of directors chairmanship position of Mr. Schultz started during 2000 (Starbucks, 2015).

McDonalds

Mr. Stephen Easterbrook, 48 yrs old, is the president as well as Chief (Executive) Officer starting on March of 2015. Mr. Easterbrook worked as Corporate Senior Executive Vice President as well as Global Brand Officer from May (2014) to February (2015). From December (2010) to September (2011), Mr. Easterbrook worked as McDonalds Europe’s President. Mr. Easterbrook worked for 22 years with McDonalds. As of December 31, 2015, the company had over 36,520 fast food restaurants strategically located around the world. Next, the figure includes more than 30,080 franchise partners using the McDonalds brand to generate higher revenues and profits. The founders of the company established the company during 1940s. The company owns more than 6,400 fast food restaurants that are well entrenched in many busy cities around the world (McDonalds, 2016).

Corporate (Governance) – Social (Perception)

• Mission Statement

Starbucks. The company has a unique mission statement (Starbucks, 2016). The statement indicates:

McDonalds. The McDonalds fast food chain has a different mission statement. The statement goes (McDonalds, 2016):

• CSR (Initiatives)

Starbucks. The company’s corporate (social) responsibility focuses on serving excellent quality products and services. The company prioritizes taking into accounting the consumer feedbacks, suggestions, recommendations, and other inputs in the continuing enhancement of the company’s corporate (social) responsibility image.

McDonalds. The company’s corporate (social) responsibility centers on protecting the environment. The responsibility activities include the use of better energy efficient production equipments and processes. The company focuses on serving food (with) integrity. The food ingredients do not use GMO –based ingredients.

II: Market Breakdown

• Stockholders Analysis

Type of Shares (common etc)

Starbucks. Starbucks has $1.5 million common type shares issued and outstanding as of December 31, 2015. There were 2,400 shares that were issued and outstanding common type shares as of the same 2015 yearend date. There are no preferred type shares that were issued and at the same time outstanding as of December 31, 2015.

McDonalds. McDonalds has $16,600 million worth of common shares as of December 31, 2015. There were 1,660.6 million shares issued and outstanding during December 31, 2015. There are no preferred shares.

b. Percentage

Table 1

Percentage

Company

Starbucks

McDonalds

Percent Shares that are being held by institution investors

78 percent

69 percent

Percent Floats that are being held by institution

80 percent

100 percent

Percentage of shares that are being held by insiders

2.67 percent

0.05 percent

The table 1 shows the difference in the performances of both Starbucks and McDonalds. The table 1 indicates the percentage picture of both Starbucks and McDonalds. In terms of percentage Percent Shares that are being held by institution investors, Starbucks generated the higher 78 percentage compared to the 69 percent shares that are being held by McDonalds institution investors. In terms of Percent Floats that are being held by institution, Starbucks generated the higher 80 percent compared to the McDonalds 100 Percent Floats that are being held by institution. In terms of Percentage of shares that are being held by insiders, Starbucks generated the higher 2.67 percent compared to the 0.05 percentage of shares that are being held by insiders (Brealey, 2011).

Market Profile

Table 2

Market Profile

Company

Starbucks

McDonalds

Credit Rating

A-

A-

Bankruptcy Volatility

1.75 percent

5.45 percent

Marginal percentage rate (tax)

35 percent

35 percent

EBITDA (millions)

$3,791

$9,612

Firm’s Value (Million - Market)

$58,147

$92,392

EBITDA/ Value

6.52 percent

10.40 percent

Industry (average)

7.88 percent

8.21 percent

In terms of table 2, there are differences between the performance of Starbucks and McDonalds (Melicher, 2011). In terms of credit rating, Both Starbucks and McDonalds generated an A- credit rating. In terms of bankruptcy (volatility), Starbucks generated the lower 1.75 percent compared to the 5.45 percent output of McDonalds. In terms of Marginal Percentage rate (tax-related), Starbucks generated the same 35 percent output as McDonalds. In terms of EBITDA, Starbucks produced the unfavorably lower $3,791 million output compared to McDonalds’ $9,612 million output. In term of Firm’s value (market), the Starbucks output was $58,147 million (Burton, 2012). The figure is unfavorably lower than the McDonalds output, $92,392 million amount. In terms of EBITDA/ Value, Starbucks produced a lower 6.52 percent output compared to McDonalds’ 10.40 percent output. In terms of industry average, Starbucks produced 7.88 percent output compared to the higher 8.21 percent McDonalds output.

III: Risk & Return Analysis

• Top Down (Analysis)

Table 3

Top Down Analysis

Starbucks

McDonalds

Alpha (Intercept)

1.61 percent

-0.17 percent

Regression Beta

0.77

0.50

Jensen’s Alpha

1.11 percent

-1.25 percent

R squared

23.5 percent

23.50 percent

In terms of table 3, Starbucks generated a different output compared to McDonalds. The 1.61 Starbucks alpha intercept is higher than the -0.17 percent alpha intercept that McDonalds produced. In terms of Regression Beta, Starbucks generated the higher 0.77 regression beta compared to the McDonalds 0.50 regression beta. In terms of R squared calculation, Starbucks created the 23.5 percent output. The output is similar to the percentage output of McDonalds during the same time period. In terms of Jensen’s Alpha, Starbucks’ performance produced the 1.11 percent output. The output is lower than the -1.25 percent output of McDonalds (Robinson, 2015).

III: Return on Investment Measurement (Entertainment2015 file)

Table 4

Return (on) Investment

Company

Starbucks

McDonalds

Return (on) Assets

21 percent

12 percent

Return (on) Equity

39.22 percent

37.02 percent

Return (on) Capital (after tax)

22 percent

20 percent

The Table 4 shows the difference in the performances of Starbucks and McDonalds. In terms of return (on) assets, Starbucks generated the higher 21 percent output. The McDonalds return (on) assets output is only 12 percent. In terms of return (on) equity, the Starbucks company generated the higher 39.22 percent output compared to McDonalds. The McDonalds output is only 37.02 percent. In terms of return (on) capital –after tax, the Starbucks company produced 22 percent output. The output is higher than the McDonalds return (on) capital after deduction of the corresponding tax is 20 percent (Robinson, 2015).

III: Capital Structure

Optimal (Financing) Mix :Debt to Capital Ratio[Leverage]: Optimal (Capital) Structure

IV: Dividend Policy (Historical Analysis)

The table 5 shows the differences in the operations output of both Starbucks and McDonalds. The dividend yield of Starbucks is 1.24 percent. The figure is lower than the McDonalds output, 3.50 percent. The Estimated (dividend) yield of Starbucks is 3.15 percent. The percentage output is lesser than the McDonalds output, 3.55 percent. The industry (average) output of Starbucks is 2.06 percent. The percentage is higher than the McDonalds output, 1.88 percent. The dividend (payout) ratio for Starbucks is 38.24 percent. The ratio is lower than the dividend (payout) ratio of McDonalds, 68 percent. The estimated dividend (payout) ratio of Starbucks is 47.7 percent. The figure is higher than the McDonalds estimated dividend (payout) ratio, 43.11 percent. The industry (average) output of Starbucks is 54 percent. The output is lower than the industry (average) output of McDonalds, 56 percent. The revenue growth of Starbucks is 11 percent. The figure is definitely higher than the revenue growth of McDonalds, -

Table 5

Dividend Policy (Historical Analysis)

Company

Starbucks

McDonalds

Dividend Yield

1.24 percent

3.50 percent

Estimated (dividend) Yield

3.15 percent

3.55 percent

Industry (average)

2.06 percent

1.88 percent

Payout ratio

38.24 percent

68 percent

Estimated Payout Ratio

47.7 percent

43.11 percent

Industry (average)

54 percent

56 percent

Revenue (growth)

11 percent

-2 percent

2 percent (Robinson, 2015).

V. Stock Valuation

The table 6 shows the valuation picture of Starbucks and McDonalds. The total assets of Starbucks for 2015 amounted to $12,445.100 million. The net debt (total debt) of Starbucks is $

Table 6

Stock Valuation

Company

Starbucks

McDonalds

Total Assets

12,445.100 million

37,938.7 million

Net Debt (Total Debt)

6,628.1 million

30,850.8 million

Equity

5,818 million

7,087.9 million

6,628.1 million. The Equity of Starbucks is $5,818 million. On the other hand, the total assets of McDonalds for 2015 amounted to the higher $37,938.7 million. The net debt (total debt) of McDonalds reached the higher $ 30,850.8 million. The Equity figure of McDonalds is $ 7,087.9 million (Robinson, 2015).

VI. Investment Returns

The table 7 shows the variance between the outputs of Starbucks and McDonalds. Starbucks’ EBIT is $3,081 million. The amount is lower than the McDonalds output. The McDonalds output is $ 7,968 million. The net income of Starbucks for 2015 is $2,068 million. On the other hand, the McDonalds output is $ 4,758 million. The McDonalds output is favor ably higher than the Starbucks output. The BV debt of Starbucks is $5,479 million.

Table 7

Returns

Company

Starbucks

McDonalds

EBIT (millions)

$ 3.081

$ 7,968

Net Income (million)

$2,068

$ 4,758

BV Debt (million)

$5,479

$14,990

BV Equity (million)

$5,274

$12,853

Return on Equity (ROE)

39.22 percent

37.02 percent

Cost (of) Equity (net of book value)

8.89 percent

9.57 percent

After Tax ROC

22.14 percent

20.10 percent

Cost (of) Capital (Book –net)

6.57 percent

6.18 percent

Return Spread (ROC – WACC)

15.58 percent

13.92 percent

EVA (million)

$1,409

$ 3,587

The McDonalds figure (BV Debt) is $ 14,990 million. The McDonalds figure is favorably higher than the figure generated by the Starbucks entity. The BV equity for Starbucks is $5,274 million. The McDonalds figure (BV equity) is $ 12,853 million. The McDonalds figure is favorably bigger than the amount generated by the Starbucks entity. The Starbucks return (on) equity is 39.22 percent. The figure is favorably higher than the figure generated by McDonalds. The McDonalds figure is 37.02 percent. The Starbucks cost (of) equity (net of book value) is 8.80 percent. The figure is favorably lower than the cost (of) equity of McDonalds. The McDonalds figure is 9.57 percent. The after tax return (on) capital (ROC) of Starbucks is 22.14 percent. The figure is favorably higher than the after tax return (on) capital (ROC) of McDonalds, 20.10 percent. The return spread is generated by deducting the WACC from the ROC. The resulting return spread of Starbucks is 15.58 percent. On the other hand, the return spread of McDonalds is 13.92 percent. The return spread output of Starbucks is better than the return spread output of McDonalds. The EVA of Starbucks is $ 1,409 million. On the other hand, the EVA of McDonalds is $ 3,587 million. The Starbucks figure indicates a better picture of the Starbucks operations compared to the EVA performance of McDonalds (Robinson, 2015).

VII. Hurdle (Rates)

Table 8 shows the difference in the hurdle performances of Starbucks and McDonalds. The debt ratio for Starbucks is 40 percent. On the other hand, the debt ratio for McDonalds is 50 percent. The Starbucks ratio is unfavorably lower than the McDonalds ratio. The beta of Starbucks is 1.1. The beta of McDonalds is 1.2. The McDonalds beta is higher than the Starbucks beta. The Equity cost of Starbucks is 8.7 percent. On the other hand, the McDonalds equity cost is 9.20 percent. The equity cost of Starbucks is unfavorably higher than the equity cost of

Table 8

Hurdles

Company

Starbucks

McDonalds

Debt Ratio

40 percent

50 percent

Beta

1.1

1.2

Equity Cost

8.7 percent

9.20 percent

Interest Rate (Debt)

3.47 percent

3.47 percent

Cost of (debt), after tax deduction

2.26 percent

2.26 percent

WACC

6.15 percent

5.72 percent

McDonalds. The interest rate for the Starbucks debt is 3.47 percent. The interest rate pegged on McDonalds is similarly pegged at 3.47 percent. The cost of (debt) after the tax is deducted id 2.26 percent. The percentage figure is similarly used in the McDonalds calculation. The weighted (average) capital cost, WACC, of Starbucks is 6.15 percent. The figure is unfavorably higher than the McDonalds weighted (average) capital cost. The McDonalds WACC is only 5.72 percent (Robinson, 2015).

IX Cost (of) Equity

Table 9

Cost (of) Equity

Company

Starbucks

McDonalds

Unlevered (beta)

0.78

0.72

Stock price

$77.21

$96.13

Equity (million – market)

$58,147

$92,392

Debt (million –market)

$7,870

$ 49,721

Equity (million –book)

$5,274

$12,853

Debt (million- book)

$5,479

$ 14,990

Debt Ratio – Market

11.92 percent

35 percent

Debt Ratio – Book

51 percent

54 percent

Table 9 affirms the difference in the cost of equity of Starbucks and McDonalds. The unlevered (beta) of Starbucks is 0.78. The unlevered (beta) of McDonalds is 0.72. The Starbucks figure is higher than the McDonalds figure. The stock (market) price of Starbucks share is $77.21. On the other hand, the stock (market) price of Starbucks share is $96.13. The McDonalds figure is favorably higher than the Starbucks output. The equity (market) of Starbucks is $58,147 million. The equity (market) of McDonalds is $92,392 million. The debt (market) of Starbucks is $7,870 million. The debt (market) of McDonalds is $49,721 million. The debt of Starbucks is favorably lower than the McDonalds debt. The equity (book) of Starbucks reached $5,274 million. The debt (book) of competitor McDonalds is $12,853 million. The debt (market) of McDonalds is unfavorably higher than the Starbucks debt. The debt (book) of Starbucks reached $5,479 million. The debt (book) of competitor McDonalds is $14,990 million. The debt (book) of Starbucks is favorably lower than the McDonalds debt. The debt ratio (market) of Starbucks is 11.92 percent. The debt ratio (market) of McDonalds is 35 percent. The Starbucks ratio is lower than the McDonalds ratio. The debt ratio (book) of Starbucks reached 51 percent. The debt ratio (book) of McDonalds is 54 percent. The Starbucks ratio is lesser than the McDonalds ratio (Robinson, 2015).

X Cost of Debt

Table 10

Cost of Debt

Company

Starbucks

McDonalds

Risk Free rate

2.17 percent

2.17 percent

Interest expense [millions]

$ 64

$ 551

EBIT millions

$ 3,081

$7,968

Spread

1.30 percent

1.30 percent

Cost (of) Debt

3.47 percent

3.47 percent

The Table 10 shows the variance between the output of McDonalds and Starbucks. The risk free rate of Starbucks is 2.17 percent. On the other hand, the risk free rate of McDonalds is similarly pegged at 2.17 percent. The interest of Starbucks is $ 64 million. The Starbucks interest expense is $551 million. The McDonalds expense figure is unfavorably higher than the Starbucks expense amount. The EBIT of Starbucks is $3,081 million. However, the McDonalds figure is pegged at $7,968 million. Definitely, McDonalds produced a favorably higher EBIT than Starbucks. The Spread of Starbucks is 1.30 percent. Likewise, the spread of McDonalds is pegged at the same 1.30 percent figure. The cost (of) debt of Starbucks is 3.47 percent. Similarly, McDonalds produced the cost (of) debt amounting to same cost of debt figure, 3.47 percent (Robinson, 2015).

Conclusion

Summarizing, the above discussion describes the financial picture of two competing fast food entities. Starbucks sells coffee to the coffee lovers. McDonalds sells hamburgers and cheeseburgers to its target clients. Even though both competitors market diverse products, they strive to persuade the target clients to visit their own branches. Some individuals prefer McDonalds products. Other individuals prefer Coffee products of Starbucks. Children will prefer hamburgers over coffee beverages. Evidently, both McDonalds and Starbucks serve the unique needs of individuals belonging to diverse market segments.