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Fall 2020 Consumer Discretionary Date Fall 2020 Consumer Discretionary Date: November 16th, 2020 Jackson Castellon Zachary Graefen Valuation Methods jackson [email protected] [email protected] DCF/EP $224.30 Cade Chadima Nate Wegener DDM $212.48 [email protected] [email protected] Relative PE (EPS ‘20) $218.73 Carter Gornick Price Data [email protected] Current Price $216.73 52 Week Range $124.23 - $231.91 Consensus 1yr Target $238.30 We recommend a SELL rating for McDonald’s Corporation. Drivers of Thesis: Key Statistics • Declining revenue and low earnings growth signals Market Cap (B) $158.66 that McDonald’s is struggling to keep pace with a Shares Outstanding (M) 758.10 growing QSR industry. We have factored this into Beta 0.84 the model by assuming a 1% growth of revenues in Dividend Yield 2.38% steady state EPS (2021E) $7.71 • Economic uncertainty due to COVID-19 continues to Performance Highlights reduce sales which accounts for our forecast of 11% Profit Margin 43.03% dip in revenue for 2020 Operating Margin 28.59% • Increasing amount of debt primarily used for repurchasing shares instead of reinvestment into ROA (TTM) 9.72% the company does not generate organic growth Risks to Thesis: • Revenue and earnings stability due to the strategic transition to the franchising operating model McDonald’s is an American quick service • Increase of technological innovation in the quick- restaurant franchise famous for fast food service restaurant business could result in surprise meals that satisfy breakfast, lunch, and upside dinner. McDonald’s operates out of • Faster than expected COVID-19 recovery timeline approximately 40,000 restaurants , 94% of may boost performance in the short-run which are franchised, and the company has locations in 118 countries and territories worldwide. McDonald’s serves around 1% of the world’s population every day. The current President and CEO is Chris Kempczinski who took the position last year. 1 continues to threaten all industries of the economy, specifically, quick service restaurants (QSR). The Consumer Discretionary team’s sell Without a current vaccine for the virus, we expect recommendation on McDonald’s Corporation is increased economic instability as we enter 2021. the result of our thorough analysis of the company’s financial condition, its products and The Federal Reserve has fully exercised its powers markets, possible catalysts for growth, the of direct lending to households, employers, and potential impacts of COVID-19, and the broader financial markets along with near-zero interest economic environment. rates and other policies to balance the market. As the Federal Reserve works to stabilize the McDonald’s is one of the most well-known brands economy, much of America faces financial distress in the world. The company offers a menu that as we end 2020 on the hopes of an added stimulus attracts a very wide customer base from all over package. the globe. McDonald’s generated $21 billion of revenue in 2019, which is down 24% from 2012. The impacts of these events directly affect Despite this, the company continues to pay McDonald’s and the rest of QSR. While most increasing dividends, repurchase shares, and issue companies struggle to navigate the crisis, long-term debt. McDonald’s experiences effects to its business of what is expected to be about $1 billion loss in net In recent years, McDonald’s investment in modern income from 2019 as seen in the financial technology such as their mobile application and statements attached to this report. Although ordering kiosks is at the forefront of the industry. McDonald’s is losing a portion of its customers due Such investment has paid off during the COVID-19 to a weak consumer effect, we expect that the pandemic and has bolstered McDonald’s leading company’s competitive advantage in reputation market share position in the quick service and operations will help their recovery. restaurant business. Analysis of Key Economic Indicators The company is not immune to the effects of COVID-19 as comparable sales, earnings, and store Unemployment and Labor Force Participation Rate(s) visits are all down year-over-year. As of now, the The unemployment rate is a key metric to gauge the world is seeing a resurgence of the coronavirus health of the economy using the portion of the which is likely to have the largest impact on McDonald’s international market, where dining-in working population that is employed. Importantly, is more common than drive-thru. the unemployment rate helps value consumer income and spending. With the help of employment Our team’s sell recommendation is based on the numbers, we achieve a greater understanding of cumulation of these points which we will delve into discretionary spending, which is especially throughout this report. conservative in high unemployment conditions. The economic shutdown prompted by COVID-19 drove the United States’ unemployment rate to 14.7% COVID-19 and the Economy in February from lows of 3.5% leading up to the The COVID-19 pandemic continues to be both a pandemic. For comparison, the peak unemployment public health and economic crisis. As of November rate following the ‘08-’09 financial crisis was 9.9%.1 As 2020, 10.3 million people have been infected and unemployment increases, the amount of consumer 240,000 have died in the United States. COVID-19 2 spending declines. The chart data found on FRED1, will be under control by the end of 2021, which will shows a significant retreat in the unemployment rate. cause the unemployment rate to settle to 5.5%. Consumer Confidence Index (CCI) Consumer confidence is another key measurement of the consumer’s perspective of the economy. We are able to gather an understanding for whether consumers are optimistic or pessimistic towards the market. And, like the unemployment rate, CCI can help quantify spending across industries. When consumer confidence is low, our expectation of spending is low. The consumer discretionary sector is enduring the effects of unconfident consumers. Source: https://fred.stlouisfed.org/series/UNRATE1 Initially, this appears to be a positive indicator, however, the retreat is caused by a decrease in labor force participation rather than people finding jobs. The explanation for what appears to be job recovery is the loss of labor force participants as seen in the 2 trend shown by the participation rate. Source: https://data.sca.isr.umich.edu/data-archive/mine.php3 As the chart above displays, University of Michigan’s CCI data3 consumer confidence metrics were exceedingly high relative to historical data. Consumer confidence had been trending at 100 leaning towards upside momentum. However, the pandemic rattled the entire economy and panicked consumers. With Source: https://fred.stlouisfed.org/series/CIVPART 2 hope on the horizon of a vaccine from Moderna or 4 The impact of high unemployment on the consumer Pfizer , our team predicts confidence to remain discretionary sector depends on the consumer’s depressed until a vaccine is readily available. We expect confidence to return to 2019 levels when a willingness to purchase non-essential goods and vaccine becomes widely distributed, mid-2021. services. When households are without income, general spending at places like restaurants declines. Our forecast anticipates consumer confidence to return to the 85-95 range and continue to the upside We expect unemployment to return to 7.1% in the once a vaccine becomes available. We believe the short-term 2020 and through early 2021 because of financial performance of quick service restaurants, increased lockdown measures. We predict the virus specifically, will continue to be affected negatively until consumer confidence recovers. 3 Consumer Price Index (CPI) rate plummeted to 150 basis points.6 The low interest rate economy has put pressure on lenders to trade The Consumer Price Index (CPI) measures changes in debt for low returns and caused buyers to struggle to the weighted price of an average basket of consumer find safe, high yielding, returns in the market. goods and services. CPI is an important indicator used to gauge the health of the economy, primarily based McDonald’s restaurants are largely funded by debt as on inflation. CPI tracks increases and decreases in seen in their income statements. Increasing debt is a basic consumer goods which is helpful to understand concerning item. We are interested in McDonald’s the fluctuation in prices. Analysts rely on this indicator decision to act on low borrowing opportunities to to examine the impact of policymakers on the decrease their current debt holdings or lower market(s) which are important to valuation and borrowing rates. We have forecasted the company to forecasting assumptions. The consumer discretionary grow their debt and have adjusted for lower interest sector relies heavily on the CPI as discretionary rates. spending varies with the price-average basket of U.S Real Gross Domestic Product (GDP) consumer goods. United States Gross Domestic Product is a significant measurement of the economy’s total goods and services production on an annualized basis. In times of economic expansion, we would expect GDP to grow steadily. As the economy grows, we expect the sectors of the economy to grow in tandem, which is a key determinant to measure the growth of any business. GDP has maintained impressive growth following the ’08 financial crisis but declined 10.25% during the pandemic which has recovered to a loss of 2.70% since highs in 2019. Source: bls.gov 5 The preceding graph shows the historical trend of CPI which is near 1.4%. The CPI represents our inflation. Currently, the 1.4% is less than the Federal Reserve’s target inflation rate of 2%. As the inflation rate rises with the FED’s benchmark, prices for company operations will rise and increase the price for common goods.
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