Company History

McDonald’s Corporation (MCD – Free McDonald's Stock Report) is the planet’s largest restaurant chain by revenue, and its iconic “Golden Arches” logo is one of the world’s most well-known corporate symbols. Despite the company’s massive size and overwhelming success, it came from very humble beginnings. Indeed, McDonald’s roots trace all the way back to 1940 when two brothers, Dick and Mac McDonald, opened McDonald’s Bar-B-Que in San Bernardino, California. Although a far cry from a modern McDonald’s, the restaurant was typical for the time; a drive-in with a large menu and car-hop service. Eight years later, the brothers retooled their restaurant, and moved to a self-service format, while paring the menu down to nine items, anchored by a 15-cent hamburger. French Fries were added to the menu a year later, replacing potato chips.

It wasn’t until 1954, however, that enterprising Multimixer salesman Ray Kroc made a call to the McDonald brothers in hopes of selling them more mixers. Kroc was mesmerized by the operation’s simple menu, low prices, and self-service format. When the brothers mentioned they were in search of a nationwide franchising agent, Kroc jumped at the chance. A year later, in 1955, Kroc opened his first McDonald’s in Des Plaines, Illinois. The restaurant got a lot of attention, not the least of which was for its bright red and white décor, and its large, Stanley Meston-designed Golden Arches. The concept proved so successful that by 1965 there were over 700 McDonald’s restaurants in the United States. That was also the year that the company held its initial public offering.

In 1966, the company introduced another iconic image, this time in the form of Ronald McDonald, who starred in the corporation’s first television commercials that same year (Ronald’s friends, Hamburgler, Grimace, Mayor McCheese, Captain Crook, and the Big Mac wouldn’t join him in McDonaldland until 1971). McDonald’s continued to blossom as a public company, adding restaurants at a steady pace and opening its first international locations in 1967. New menu items were also introduced, including the Big Mac (1968), the Quarter Pounder (1973), and the Egg McMuffin (1975), which ushered in the company’s breakfast menu. Today, McDonald’s owns or franchises roughly 35,000 restaurants in nearly 120 countries, and in 2012, foreign sales accounted for approximately 68% of the company’s total revenue. Although the menu still includes well-known hamburgers and French Fries, McDonald’s now serves up salads, coffee drinks, desserts, and an array of breakfast items.

Business Model

The majority of McDonald’s restaurants are franchised (roughly 81% as of June 30, 2012), either through traditional franchise arrangements, developmental licenses, or affiliates. By far the most common is the conventional franchise arrangement, in which franchisees provide a portion of the capital needed to buy equipment, signs, seating, décor, etc. The company, on the other hand, owns or has a long-term lease on both the land and the building. Franchisees reinvest in their restaurants over time, in addition to paying McDonald’s rent and royalties. Under a developmental license, franchisees provide the capital for the entire restaurant, including real estate, and McDonald’s has no equity stake in the venture, though it does get royalty payments. In a small number of foreign markets, McDonald’s has affiliates, which are similar to conventional franchise arrangements in that the company has an equity stake in the restaurants.

Although the company has dabbled in other profitable ventures over the years, the focus now lands clearly on the McDonald’s brand. To wit, interests in Red Box Automated Retail, Pret A Manger, Boston Market, and Chipotle Mexican Grill (CMG) were sold in 2009, 2008, 2007, and 2006, respectively.

Keeping with the theme of focusing on the core brand, management is working to be better, not just bigger. Extended hours, innovative menu items (including beverages), a strong value proposition, and classic sandwiches have all helped boost comparable-store sales and make existing restaurants more profitable. Of course, this doesn’t mean that the store count isn’t expanding, especially in foreign markets. Indeed, management added 259 restaurants in 2010, 773 in 2011, and 970 in 2012.

Investment Considerations

Over the years, McDonald’s has earned a well-deserved reputation for increasing both earnings and dividends at a steady pace. To wit, in the trailing 10-year period through 2012, earnings per share grew at an average annual rate of 14.0%, while dividends per share increased at a 27.0% clip. Cash flow is typically strong, as well, easily covering capital expenditures and dividend payments in most years. Shareholder return is one of management’s key goals, which it seeks to achieve through dividends and stock repurchases. In 2012, dividends and stock buybacks amounted to $5.5 billion (roughly $5.50 a share). Further, the balance sheet is typically solid, with ample amounts of cash on hand. Finally, McDonald’s business is largely recession resistant thanks to its value and reasonable prices. Combined, these factors make McDonald’s stock popular with conservative investors.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.