McDonald’s Corporation (NYSE:MCD) owned a majority stake in Chipotle Mexican Grill, Inc. (CMG) it divested itself by 2006. It also divested itself of other acquisitions like Donatos Pizza and Boston Market to focus better on its own business. Today we look at whether it might make sense for the company to make new acquisitions.

CapitalCube’s M&A analysis is peer-basedand uses the following list of peers: Starbucks Corporation (NASDAQ:SBUX), Yum! Brands Inc. (YUM), Chipotle Mexican Grill, Inc. (CMG), Tim Hortons Inc. (TMI), Darden Restaurants Inc. (DRI), Whitbread PLC (WTB), Panera Bread Co. Cl A (PNRA), Brinker International Inc. (EAT), The Wendy’s Co. (WEN), Cracker Barrel Old Country Store Inc. (CBRL).

You can read our Fundamental Analysis for MCD here.

Corporate Actions

M&A Action

Acquirer
McDonald’s Corporation (NYSE:MCD) -US may acquire other firms within this peer group because of its large size, relatively attractive valuation and current relatively low growth expectations.
McDonald’s Corporation (NYSE:MCD) -US is one of the larger companies in this peer group and thus difficult to acquire.

Dividend Action

While MCD-US’s relatively good operating performance, leverage and liquidity along with a high dividend quality support an increase in dividend, the combination of its valuation, relative growth expectations and share price performance combined with a weak cash cushion (for its dividend) does not seem to support a dividend increase.

Equity Action

The company’s current share price is not sufficiently lower than its 52-week high (currently about 10% below) and does not justify a share buyback as the best use of cash at this time.

M&A Action

Why merge or acquire?

Companies typically acquire to realize economies of scale, scope, gain customers, bundle complementary products, or gain vertical integration. From an investor’s perspective, these business reasons fall into natural screening categories that include: (a) buying companies to boost growth expectations; (b) buying to realize cost synergies; and (c) buying earnings through acquisitions that increase EPS.
Potential targets would typically be smaller than their peers though sometimes targets can be marginally larger than the acquirer. As a result, when identifying a company as a target, we check for a book value that is up to 80% more than the peer median. In addition, we also filter for a cheap valuation relative to peers (i.e. price to book is less than the peer median) and a share price that is trading sufficiently (i.e. at least 20%) below its 52-week high.
M&A Target Conditions MCD-US Comparable Pass/Fail
Book value <= 1.8 x Peer median 14,035.1 3,315.6 Fail
% below 52-week high share price >= 20% 10.3 20 Fail
Price to book (P/B) <= 1.2 x Peer median* 6.6 8.2 Pass
* We use a 20% tolerance (0.8-1.2x) around the median.
Typically, acquirers are larger than their peers though, as mentioned above, targets can sometimes be marginally larger than the acquirer. To identify a company as an acquirer, we look for a book value that is around or more than the peer median and for growth expectations (measured by its price to earnings or P/E) that are lower than peer median. In addition, we consider whether the company has the capacity to add intangible assets (like goodwill) and whether its valuation (measured by its price to book or P/B) is attractive relative to its peers.
M&A Acquirer Conditions MCD-US Comparable Pass/Fail
Book value >= 0.8 x Peer median 14,035.1 1,473.6 Pass
Price to earnings (P/E) <= 1.2 x Peer median* 17.3 24.8 Pass
Net tangible assets to equity >= 25% 80.9 25 Pass
Price to book (P/B) >= 0.8 x Peer median* 6.6 5.4 Pass
* We use a 20% tolerance (0.8-1.2x) around the median.
MCD-US could potentially acquire other companies within this peer group.

The market’s current relatively low growth expectations for MCD-US imply it would need acquisitions to grow. The company’s book value of USD14,035 million gives it the size to make acquisitions in this peer group. In addition, its comparatively low proportion of intangible assets suggest that the company has some room to acquire — even possibly using its equity which is currently trading at a higher price to book (P/B) relative to peers.

MCD-US’s large book value would make it difficult to acquire in this peer group.

MCD-US’s book value of USD14,035 million makes it one of the larger companies in this peer group and thus difficult to acquire.
Likely M&A Action or Growth Strategy based on P/B vs. Net Tangible Assets/Equity (%) charted with respect to PeersMcDonald's Corp. (MCD)

Dividend Action

Dividend cut, increase or initiate?

In this section, we try to identify whether the company is likely to cut, increase or initiate a common stock dividend. In order to screen for these actions, we apply multiple tests to check whether the combination of operating performance, leverage, liquidity, growth expectations and share price performance is sufficient to permit such an action.
To check for a dividend increase at MCD-US, we look for outperformance relative to its peers in terms of pre-tax margin and operating cash flow. In addition, we also filter for relatively low leverage and good liquidity, which indicates sufficient support for debt servicing. We also look for a price to book value (P/B) that is positive, relatively low growth expectations (based on P/E) and a share price that has underperformed its peers. Overall, these conditions suggest that there is pressure on management to return money to the shareholders in the form of a dividend in order to increase their total returns. Finally, we overlay the dividend quality (medium or high) and ending cash dividend coverage (moderate or strong) to indicate whether the company is likely to increase its dividend.
Dividend Increase/Initiate Conditions MCD-US Comparable Pass/Fail
Dividend payout <= 100% (= 0% for initiate) 51.0 100 Pass
Pre-tax margin >= 1.2 x Peer median* 29.2 17.4 Pass
Free cash flow (% revenue) >= 1.2 x Peer median* 15.1 8.7 Pass
Interest coverage >= 2.5x 16.5 2.5 Pass
Debt to market equity <= 1.2 x Peer median* 15.2 18.2 Pass
% below 52-week high share price >= 1.2 x Peer median* 10.3 12.3 Fail
Price to earnings (P/E) <= 1.2 x Peer median* 17.3 24.8 Pass
Price to book (P/B) >= 0 6.6 0 Pass
Dividend quality = Medium or High High Medium or High Pass
Ending cash/dividend >= 3 (Strong) or 1 (Moderate) Weak Strong or Moderate Fail
* We use a 20% tolerance (0.8-1.2x) around the median.
To check for a dividend cut at MCD-US, we look for underperformance relative to its peers in terms of pre-tax margin and operating cash flow. In addition, we filter for interest coverage that is somewhat tight, which combined with a low dividend quality and a weak ending cash cushion would suggest that a dividend cut is likely .
Dividend Cut Conditions MCD-US Comparable Pass/Fail
Pre-tax margin <= 0.8 x Peer median* 29.2 11.6 Fail
Free cash flow (% revenue) <= 0.8 x Peer median* 15.1 5.8 Fail
Interest coverage < 2.5x 16.5 2.5 Fail
Dividend quality = Low High Low Fail
Ending cash/dividend < 1 (Weak) Weak Weak Pass
* We use a 20% tolerance (0.8-1.2x) around the median.
Fundamentals do not support a change in dividend policy in the near-term.

The combination of MCD-US’s operating performance and interest coverage does not seem to justify a dividend cut. In addition to margins and cash flow levels that are relatively good compared to peers, the company’s leverage and liquidity ratios suggest the company can easily service its current debt. The high dividend quality also supports a dividend increase. However, the company’s valuation, growth expectations and relative share price performance combined with a weak cash cushion (just 0.9x the cash dividend) do not seem to support a dividend increase.
Likely Dividend Action based on Dividend Support from Operations or Pre Tax Margin % vs Free Cash Flow (% Revenue) charted with respect to Peers for McDonald's Corp. (MCD)

Share Buyback

Is the company likely to buy back shares?

In this section, we identify whether MCD-US is likely to buy back its shares. In order to screen for this event, we look for positive free cash flows and good liquidity in addition to a leverage, an earnings multiple and a current share price that are low enough to suggest that there

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