McDonald’s ($MCD) Headed for the Value Menu

As one of the top global brands and the company that fathered the modern concept of a franchise, it would seem all there is to be said about McDonald’s (MCD) as already been said. With over 20 regular analysts covering McDonald’s stock price and hundreds of finance articles dedicated to the company one might assume any divergence from intrinsic value would quickly be corrected. Yet this crazy rodeo of a stock market may have just pushed McDonald’s price a bit too low.

My typical value investment is a small- to mid-cap company with years of modest results and tangible assets and products. These are not the “sexy” tech or alternative energy stocks, but they have performed very well throughout my investing history. Very rarely do I find a solid, reputable large-cap truly undervalued, but as I detail below, McDonald’s may soon be on this list.


McDonald’s is not clowning around

Macro issues such as jobs reports and European debt problems have hammered all stocks as of late, including McDonald’s. McDonald’s has done nothing to deserve the fury of the selloff. Their operations span the globe (119 countries) and their business is not seasonal. They have found their secret recipe for success and stick to it. I am not the biggest fan of their fare but I love their razor’s edge efficiency and productivity. Before we turn to the financial results we should all agree that on a smell test McDonald’s is stable and predictable.

For a mature company such as McDonald’s their growth is surprising. Net Income has increased each of the past three years, 9% from 2009 to 2010 and 11% from 2010 to 2011, but growth means nothing more than a warm feeling unless it is outpacing their market price. When valuing a company my first step is a famous quick-check known as Tobin’s Q. Tobin’s Q compares the market value of the company to the total assets of the company. A result less than 1 generally indicates that a company is undervalued based on assets. McDonald’s result is a 2.8, which is high but not a determining factor in my ultimate decision. I can accept the 2.8 much easier when I consider the largest group of assets held in the company is real estate, and most of their holdings are prime locations throughout the world. With property prices still depressed it makes sense that asset value is on the low end.

My second quick-check, the Buffett Formula, goes deeper and values the company on three years of Net Income, Depreciation and Capital Expenditures and discounts using the average investment grade bond yield. This formula ignores industry and market factors and calculates a value solely on the company’s results. McDonald’s Buffett Formula intrinsic value is presented as $123.18 for a 26% margin of safety. Not a stellar result but nearly undervalued (I require a 30% margin for undervalued status).

My final calculation is where I derive my overall intrinsic value – the result which will drive my buy/sell decision. This formula is my Valuator formula, which gives me both an internal valuation of McDonald’s and an industry valuation for a robust, confident intrinsic value. I choose Starbucks Corporation (SBUX), Yum! Brands, Inc. (YUM), Tim Hortons Inc. (THI) and Panera Bread Co. (PNRA) for my comparables. The result is an intrinsic value of $123.88, only $0.70 difference from the Buffett Formula result! This reveals an even consensus of McDonald’s true company value on both internal and external examinations.

With McDonald’s having an intrinsic value of $123.88 for a 27% margin of safety I cannot label them as textbook-defined undervalued – but they are very close. Not a bad buy for the risk-takers, and the more conservative investors can hold out for the price to fall even further. Friday’s selloff pushed them down $2.63, or 2.94%. I am putting a buy watch on McDonald’s and I see them on the Value Menu the minute they fall below $84.50.