A Look At The Fair Value Of McDonald's Corporation (NYSE:MCD)

Simply Wall St · 10/15 10:12

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, McDonald's fair value estimate is US$338
  • With US$310 share price, McDonald's appears to be trading close to its estimated fair value
  • Analyst price target for MCD is US$306 which is 9.6% below our fair value estimate

How far off is McDonald's Corporation (NYSE:MCD) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for McDonald's

The Method

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034
Levered FCF ($, Millions) US$8.66b US$10.2b US$11.4b US$12.4b US$13.3b US$14.0b US$14.6b US$15.2b US$15.7b US$16.2b
Growth Rate Estimate Source Analyst x8 Analyst x4 Analyst x1 Analyst x1 Est @ 6.60% Est @ 5.37% Est @ 4.51% Est @ 3.91% Est @ 3.48% Est @ 3.19%
Present Value ($, Millions) Discounted @ 7.6% US$8.0k US$8.8k US$9.1k US$9.3k US$9.2k US$9.0k US$8.7k US$8.4k US$8.1k US$7.8k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$86b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.5%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.6%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$16b× (1 + 2.5%) ÷ (7.6%– 2.5%) = US$325b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$325b÷ ( 1 + 7.6%)10= US$156b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$243b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$310, the company appears about fair value at a 8.4% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
NYSE:MCD Discounted Cash Flow October 15th 2024

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at McDonald's as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 7.6%, which is based on a levered beta of 1.240. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for McDonald's

Strength
  • Debt is well covered by earnings and cashflows.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Earnings growth over the past year underperformed the Hospitality industry.
  • Dividend is low compared to the top 25% of dividend payers in the Hospitality market.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Total liabilities exceed total assets, which raises the risk of financial distress.
  • Annual earnings are forecast to grow slower than the American market.

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For McDonald's, we've compiled three additional elements you should further research:

  1. Risks: As an example, we've found 2 warning signs for McDonald's that you need to consider before investing here.
  2. Future Earnings: How does MCD's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.