Erasmus Platform for Sustainable Value Creation
Case study
McDonald's
Willem Schramade!
!
McDonald's:
a sustainable
finance case study
September 2019
Willem Schramade"
Erasmus Platform for Sustainable Value Creation
Important: this company analysis was done for educational purposes. It is not
an investment recommendation nor does it in any way reflect the opinion of
RSM, Erasmus University. Target prices were calculated only to illustrate ways of
thinking about value.
!
| Erasmus Platform for Sustainable Value Creation3
Abstract
4
Introduction
5
The list of questions
6
Answering the questions for McDonald's
9
Conclusions and reflections
27
References
28
Important: this company analysis was done for educational purposes. It is not
an investment recommendation nor does it in any way reflect the opinion of
RSM, Erasmus University. Target prices were calculated only to illustrate ways of
thinking about value.
This is the third in a series of RSM case studies on sustainable finance. Using a list
1
of questions, we show how to integrate sustainability into investment analysis by
connecting sustainability to business models, competitive position, strategy and
value drivers. Here the questions are answered for McDonald’s, a company that
faces substantial sustainability challenges, on both the social (health) and
environmental (footprint) dimensions. Our findings suggest that McDonald’s is not
as well positioned as Philips, but much better than Air France-KLM. Unlike the
latter, McDonald’s does have significant options to deal with its sustainability
issues. However, our ability to properly assess its transition preparedness is
hampered due to the absence of essential data: McDonald’s sustainability
reporting is limited and lacks targets and numbers. Unfortunately, this is typical of
current reporting practices.
1
Abstract
After Philips (https://www.rsm.nl/fileadmin/Images_NEW/Erasmus_Platform_for_Sustainable_Value_Creation/
1
Case_Study_Sustainable_Finance_Royal_Philips.pdf) and Air France-KLM (https://www.rsm.nl/fileadmin/Images_NEW/
Erasmus_Platform_for_Sustainable_Value_Creation/Case_study_KLM_01.pdf)
| Erasmus Platform for Sustainable Value Creation4
In this case study we analyse McDonald’s, a company that faces substantial
sustainability headwinds.
We chose McDonald’s because it highlights the predicament of a company that
performs very well financially as long as its negative externalities are not
internalized. Like the other cases in this series (on Philips and Air France-KLM), it
presents a list of questions that allow analysts to integrate sustainability into
investment analysis by connecting sustainability to business models, competitive
position, strategy and value drivers.
Our finding suggest that McDonald’s is not as well positioned as Philips to meet its
sustainability challenges. Like Air France-KLM, McDonald’s faces serious
sustainability challenges both on the social (health) and environmental (carbon
footprint) side. However, its odds of overcoming these headwinds look much
better than at Air France-KLM: McDonald’s is more profitable, more advanced in
terms of sustainability reporting and thinking, and it has significant options to deal
with these issues. For example, the company has taken initiatives to make its food
healthier but encountered lukewarm consumer response; and its supply chain
initiatives look promising, be it with the suspicion of green washing. However, it
needs to be emphasized that essential data is missing as McDonald’s sustainability
reporting is limited and lacks targets and numbers. This puts a large question mark
on the company’s transition preparedness. Investor engagement could alleviate
this problem.
Like the other cases in this series, this one highlights the need for fundamental
analysis (that is, going well beyond ESG ratings) to properly assess a company’s
transition preparedness, which we deem the essence of corporate sustainability.
This article is set up as follows: in the next section, the list of questions is
presented. In the subsequent section, the questions are answered for McDonald’s,
starting with the company’s business model and value drivers, before diving into
strategy and sustainability. It then goes back to the value drivers and the
investment case to see how they have been affected by the sustainability analysis.
In this way, the analyst develops a holistic view of the company. The final section
concludes and reflects.
2
Introduction
| Erasmus Platform for Sustainable Value Creation5
The below list of questions (Table 1) has been made over the course of several
years of doing ESG integrated investment analysis, and is exactly the same as in
the Philips case. More recently, they have been structured as an assignment for
the Sustainable Finance course taught at Erasmus University and can be found in
our Sustainable Finance textbook (Schoenmaker and Schramade, 2019, Chapter
8).
They are meant to deepen students’ and practitioners’ understanding of ESG
integration by having them apply sustainable finance insights to a real life example
– and ideally discuss with fellow students or colleagues. They are 25 questions
(even more including sub-questions) in six sections. Although the six sections
address different issues, it should become obvious during the analysis that they are
very much related.
TABLE 1 LIST OF SUSTAINABLE FINANCE QUESTIONS FOR ESG INTEGRATION!
3
The list of questions
Section
Questions
1. Business
model &
competitive
position
1.How would you describe the company’s business model?
2.How strong do you rate the company’s competitive position?
3.What trends affect the company’s business model and competitive
position?
2. Value drivers
(part 1)
1.Sales growth: what seems to be a normal sales growth for the
company? And what are the drivers of sales growth?
2.Margins: what seems to be a normal profit margin (EBIT or EBITDA)
for the company? And what are the drivers of that margin?
3.Capital: how capital intense is the company? What do you think is
the firm's cost of capital? What is the firm's return on invested capital
(ROIC)
4.Please sketch how you see the company’s value drivers going
forward?
| Erasmus Platform for Sustainable Value Creation6
3. Sustainability
1.Purpose: what is the company's mission / purpose / raison d'être? In
what way does the company create value for society? How does it
get paid for that value creation?
2.Stakeholders: what are the company's main stakeholders? Please fill
out the stakeholder impact tool
3.Externalities & impact: Does the company generate serious
externalities? Are they positive or negative? How do you assess the
chances of these externalities to be internalized? Thresholds: how
does the company perform versus the planetary boundaries?
4.SDGs: which of the SDGs (if any) does the company help achieve?
Which negative SDG exposures (if any) does the company have?
5.Impact: to what extent can the company’s impact be measured?
Does the company report on its impact? How can its impact reporting
be improved?
6.Material issues: what are the most material ESG factors? I.e., what
issues are most critical to the success of the company's business
model? Please fill out the given matrix, discussing for each of these
most material ESG factors (1) how the company performs on it; (2)
whether the company derives a competitive (dis)advantage from it; (3)
how they might affect the value drivers
7.Sustainability reporting: how do you assess the company’s non-
financial reporting? Does the company (claim to) do Integrated
Reporting (<IR>)? To what extent do you see the seven principles of
<IR> reflected in the company’s reporting?
4. Strategy
1.How would you describe the strategy of the company?
2.To what extent does that strategy take into account the company's
most material ESG issues? Please link to your answer in the
sustainability section.
3.Is the strategy consistent with the company's purpose?
4.What does long-term value creation look like? What are the best
KPIs for it?
5.What does management compensation look like? To what extent
does management have long-term incentives? And are those
incentives aligned with long term-value creation?
6.How does the company communicate its long-term value creation
with shareholders and stakeholders?
5. Value drivers
(part 2)
1.Given all of the above questions & their answers, how do you rate
the effect of material sustainability issues on the value drivers going
forward? Per value driver, please indicate whether you see a positive,
negative or neutral effect
2.How would this affect your valuation of the company?
| Erasmus Platform for Sustainable Value Creation7
Source: authors
Of course, these questions can be answered either very high level or in a very
detailed way. And not all questions will need to be answered every time or right
away. Ideally, priorities will depend on the needs of the user and the relevance of
the particular issue in the context at hand. It certainly should not be a matter of
perfectionism or box-ticking, as answering the questions is not a goal in itself but
meant to build a good holistic understanding of a company’s transition
preparedness and investment attractiveness.
6. Investment !
conclusions
1.How well prepared do you think McDonald's is for the transition to a
more sustainable economic model?
2.How attractive do you find the company as an investment?
3.What did you find most surprising when answering the above
questions?
4.If you were to engage with the firm, what topics would you address?
| Erasmus Platform for Sustainable Value Creation8
"
In this section, the questions are answered for McDonald’s. We answered the
questions based on publicly available material. Ideally, the answers serve as a
useful illustration and help answering the same or similar questions for different
companies as well.
1. Business model & competitive position
See Chapter 5 of Schoenmaker and Schramade (2019) for a description of the
below concepts and how they relate to each other. "
Business model & competitive position!
1.1. How would you describe the company’s business model? What
are its customer value proposition and profit formula?
2
McDonald's is the world's largest restaurant chain with 36,000 stores in over 100
countries. The vast majority (>90%) of these stores are run as franchises. As they
say it : “The power of our franchisees, suppliers and employees working together
3
toward a common goal is what makes McDonald’s the world’s leading quick-
service restaurant brand”. And McDonald's founder Ken Croc defined its value
proposition in this way: “McDonalds stands for friendliness, cleanliness,
consistency, and convenience”.
The company essentially has two profit formulas:
•
One for the restaurants the company owns, where it gets all revenues and bears
all costs;
•
And one for the franchised restaurants, where it gets rent payments, and royalty
fees that depend on a percentage of the franchisees’ sales.
4
Answering the questions
for McDonald's
Johnson et al. (2008) argue that a successful business model has three components:
2
1. the model helps customers perform a specific ‘job’ that alternative offerings do not address;
2. the model generates value for the company through factors such as the revenue model, cost structure, margins
and/or inventory turnover;
Key resources and processes: the company has the people, technology, products, facilities, equipment and brand
required to deliver the value proposition to targeted customers. The company also has processes (training,
manufacturing, services) to leverage those resources.
https://corporate.mcdonalds.com/corpmcd/about-us/our-business-model.html
3
| Erasmus Platform for Sustainable Value Creation9
At the latter, the company’s revenues are lower, but its margins are much higher.
Although franchised restaurants remain independent and manage their day-to day
operations themselves, McDonald’s supervises them and controls the quality of
food and services. In company-owned restaurants, McDonald’s develops and tests
innovations, improve operations and pricing, and train employees. McDonald’s
owns the land and buildings (or has long-term financial leases), so that it has a
greater control over franchises and a source of additional income. McDonald’s
subleases restaurants with a 40% mark-up.
1.2. How strong do you rate the company’s competitive position?
McDonald’s enjoys a strong competitive position in the Informal Eating Out
segment (IEO) versus peers such as Burger King and KFC. Its major strength is its
network: franchises, landowners, and supply chain. The franchise model allows
McDonald’s to expand without overcomplicating the management system.
McDonald’s focuses on the development of the brand by setting standards for the
food chain, doing market research and advertisement. Moreover, the model
preserves incentives for managers of restaurants, who are at the same time self-
employers. The model also allows McDonald’s to serve locally relevant food
because restaurants are run by local entrepreneurs who are familiar with regional
food preferences.
The company’s position is not undisputed however, and the market has become
more blurred with the competition from new entrants: online delivery platforms
and convenience and grocery stores.
1.3. What trends affect the company's business model and
competitive position?
Several trends can be identified:
•
Urbanization and a growing middle class in emerging markets drive demand for
meat and fast food restaurants – a clear positive for McDonald’s
4
•
Digitalization. Customers have become more used to technological innovations
and require higher quality services. Greater customer experience can be
achieved through digitalization of delivery and services in the restaurants.
Moreover, digitalization can reduce costs and optimize the control over the
supply chain – an opportunity for McDonald’s to further expand its scale
advantage over competitors, but also a threat from online delivery companies.
•
Increasing health awareness due to the surge in chronic diseases like diabetes -
a threat for McDonald’s
Global meat production grew almost 2% per year over the past decade and is expected to grow by 1% per year over the next decade
4
(FAO, 2018, “Transforming the livestock sector through the Sustainable Development Goals”)
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•
Climate change mitigation measures will likely put limits on the growth of meat
production – a threat for McDonald’s
So, a mixed picture emerges as the first two trends are positives for McDonald’s,
and the latter two are negatives.
2. Value drivers - part 1
Sales growth!
2.1. What seems to be a normal sales growth for the company? Please
explain. And what are the drivers of sales growth?
Optically, sales growth turned negative in 2014. However, this was driven by a
deliberate strategy to reduce the number of restaurants owned in favor of
franchisees, which makes the business model more asset light. The company’s
target is to achieve a comparable sales growth of 3-5%. The main drivers are the
number of customers and the average value of the bill.
Margins!
2.2. What seems to be a normal profit margin (EBIT or EBITDA) for the
company? Please explain. And what are the drivers of that
margin?
McDonald’s has a history of high margins (around 30% EBIT margin), and in recent
years margins have gone even higher (over 40%). This was driven by the increasing
proportion of franchised (80% margin) vs owned restaurants (17% margin). That is
not without risk though as franchisees might stop accepting high fees.
Underlying drivers of margins include comparable sales and occupancy costs, the
size of royalties as % of revenue, and the currency translations effects for franchise
sales. For company-operated margins the main drivers are comparable revenues,
commodity prices, personnel costs, and VAT.
Capital
2.3. How capital intense is the company?
By end 2018, McDonald’s had $32.8 billion in assets and $29.8 billion invested
capital (IC) . With sales of $21.0 billion, the firm’s capital intensity (IC/sales) is 1.4.
5
This is higher than at the typical company and similar to the 1.5 we see at an
aluminum company. However, McDonald’s has much higher margins than the
latter and hence has much higher ROIC.
Invested capital deviates from total assets as non-operating assets (such as stakes and excess cash) and non-interest bearing short
5
term liabilities are deducted from total assets to arrive at invested capital.
| Erasmus Platform for Sustainable Value Creation11
2.4. What do you think is the firm's cost of capital? Please explain
McDonald’s’ levered beta is 0.68 on a 5 year monthly basis. Due to its leverage
(Net debt/Equity =30/136=0.22), its unlevered beta is even lower, at 0.56
6
(0.68/1.22=0.56). As its beta is well below 1, McDonald’s can be considered a
defensive stock.
Assuming a long-term risk-free rate (Rf) of 4% and long-term market expected
return (Rm) of 8%, its WACC becomes: 4%+0.56*(8%-4%)=6.2%.
2.5. What is the firm's return on invested capital (ROIC)? Please
explain
With 2018 NOPLAT at $6.3bn, McDonald’s has ROIC=NOPLAT/IC=6.3/29.8=21%.
7
This is quite high, well above the company’s cost of capital of 6.2%. However, it
remains to be seen if the company can sustain such levels in the future.
Value driver overview
2.6. Please sketch how you see the company's value drivers going
forward in the table below
TABLE 2: VALUE DRIVER ASSESSMENT FOR MCDONALD'S!
Source: athors' analysis
8
Value driver
Market
implied per 4
June 2019
Extrapolation
of the 2021
expectations
Our
assessment
for the next
decade,
before ESG
analysis
Our
assessment for
the next
decade, after
ESG analysis
Sales growth
4%
4%
3%
2%
EBIT margins
44%
47%
43%
40%
WACC
6.2%
6.2%
6.2%
7%
Resulting !
fair value
$199
$219
$184
$129
Source: Bloomberg
6
NOPLAT=Net operating profit less adjusted taxes. See for example Koller et al. (2015).
7
Market implied per 4 June 2019 sales growth in line with management guidance of 3-5%
8
| Erasmus Platform for Sustainable Value Creation12
The market seems to price in 4% sales growth (i.e. in the middle of company
guidance), while maintaining the 44% EBIT margins at a 6.2% WACC. Extrapolation
of the expectations for 2021 (i.e. 47% margins) gives a 10% higher stock price
($219).
Even before doing our ESG integrated analysis, we were skeptical of McDonald’s
ability to keep on growing and expanding margins, resulting in a fair value
assessment of $184 (5% downside to the $199 share price on 4 June 2019). As we
will explain later, our ESG integrated analysis resulted in negative growth and
falling (but still high) margins, and a fair stock price of $129, i.e. 34% lower than the
price at the time of writing. This suggests that risk is much higher than widely
perceived.
3. Sustainability
Purpose
3.1. What is the company's purpose / raison d'être? In what way does
the company create value for society? How does it get paid for
that value creation?
McDonald’s aims to be its customers’ favorite place and way to eat and drink
(Mission statement 2013). Along with its Customer Value Proposition, this implies
value creation for society in terms of affordability and convenience. In addition,
the company advertises four corporate values : responsible leadership;
9
inclusiveness; progressiveness; and local integration. However, it can be argued
that the company also destroys value for society due to the negative health and
environmental effects of its products. Still, the company operates a very successful
profit formula (see value driver section above).
Stakeholders
3.2. What are the company's main stakeholders? Please fill out below
the stakeholder impact tool
On its corporate website, McDonald’s mentions an impressive list of initiatives
where it engaged its stakeholders , including its participation in roundtables on
10
palm oil and sustainable beef. However, we could not find a list or mapping of
https://corporate.mcdonalds.com/corpmcd/about-us/our-values.html
9
https://corporate.mcdonalds.com/corpmcd/scale-for-good/using-our-scale-for-good/engaging-stakeholders.html
10
| Erasmus Platform for Sustainable Value Creation13
stakeholders that allows for a structured analysis and overview. In that end, using a
stakeholder impact map is very useful.
TABLE 3: STAKEHOLDER IMPACT MAP FOR MCDONALD'S
Source: authors' analysis
Just like in the Air France-KLM case, the McDonald’s stakeholder impact map
shows serious frictions between what stakeholders want and what they get:
•
Customers: healthy versus tasty & cheap
•
Employees: low pay
•
Society: high carbon footprint & health issues
These frictions stand in stark contrast to the Philips case, where the stakeholder
impact map found very limited friction among stakeholders. Most companies
seem to be in between, with less but still significant frictions among stakeholders.
We find it educationally rewarding to discuss stakeholder impact maps and their
frictions in a group. Our teaching sessions showed that, with a bit of help, a group
of students can get to the core of such issues very fast.
Employees
Franchisees
Suppliers
Customers
Society &
government
Long-
term !
goals
Good work-life
balance and
salaries;
Personal
development,
professional
pride &
financial/job
security
Profits
Good prices,
stability
Cheap,
healthy, tasty,
convenient,
fast food
Healthy
population,
low
environmental
footprint &
high tax
income
How the
company
helps those
goals
Pay and job
fulfilment
Brand, supply
chain, digital
innovation
Long-term
contracts
Low prices,
initiatives for
healthier
products
Paying taxes,
efforts to
reduce its
footprint
How the
company
hurts those
goals
Demanding
work
environment;
long hours;
low pay?
Fees paid,
tight control
system
Switching,
hold-up
problems
Unhealthy,
slow, smelly
Unhealthy
food, high
carbon
footprint, poor
pay (including
lobbying
against US
minimum
wage)
| Erasmus Platform for Sustainable Value Creation14
Externalities & impact
To guide the transition towards a sustainable and inclusive economy, the United
Nations has developed the 2030 Agenda for Sustainable Development. The 17 UN
Sustainable Development Goals (SDGs) stimulate action over the years 2015-2030
in areas of critical importance for humanity and the planet. This should result in a
serious reduction in negative externalities. The corporate sector too is increasingly
working on the internalisation of externalities, which is a threat for some and an
opportunity for others (e.g., Schramade, 2017). However, even if the SDGs are
achieved, that does not guarantee that we stay within the planetary boundaries
identified by Steffen et al. (2015) – beyond which climate may change so
dramatically that life on earth becomes hard if not impossible.
3.3. Does the company generate serious externalities? Are they
positive or negative? How do you assess the chances of these
externalities to be internalised?
McDonald’s produces two seriously negative externalities:
1. Negative health effects;
2. Negative environmental effects.
Both these effects help make McDonald’s (meat) products artificially cheap, which
is not a sustainable situation.
NEGATIVE HEALTH EFFECTS
McDonald’s is famous for its burgers and fries, but such food is unhealthy, adding
to unbalanced diets and high rates of obesity and diabetes – which are on the rise
globally. Moreover, the use of antibiotics makes meat cheaper to produce but also
even more unhealthy for consumers. The latter is now being addressed as
McDonald’s recently announced a plan to reduce the use of antibiotics in its
supply chain . However, even after the removal of antibiotics, most of McDonald’s
11
products are still unhealthy. That externality is likely to be internalized in two ways.
First, consumer awareness of unhealthy eating habits is on the rise, with rising
demand for healthier food in developed markets. So far, however, the impact on
McDonald’s has been small as such awareness is mostly limited to a subset of
consumers that isn’t part of the company’s core customer base. In fact, the
company’s experiments with healthier food have large been unsuccessful for that
very reason. Those experiments though, do show that McDonald’s has significant
optionality to deal with this threat. The same applies to the emergence of
suppliers of meatless burgers, such as Beyond Meat, which recently made
successful stock market entries.
The second way for this externality to be internalized is regulation. Governments
might impose stricter requirements on the nutritional value of food quality, or
even levy taxes on salt, fat and sugar. Such measures would lead to higher input
https://www.dairyherd.com/article/mcdonalds-announces-antibiotic-policy-beef
11
| Erasmus Platform for Sustainable Value Creation15
prices for McDonald’s, and force the company to raise its own prices as well. This
would threaten the affordability of its products, a core component of its customer
value proposition and business model.
NEGATIVE ENVIRONMENTAL EFFECTS
McDonald’s produces large negative environmental effects, due to its extensive
use of packaging (often plastics) and the deforestation and carbon emissions that
result from the meat it uses.
The packaging problem in particular is being tackled. In 2018, McDonald’s
announced that by 2025, all of its packaging should come from renewable,
recycled or certified sustainable sources . In addition, the company aims to
12
recycle guest packaging in 100% of McDonald’s restaurants (versus circa 10% in
2018) – while admitting that “recycling infrastructure, regulations and consumer
behaviors vary from city to city and country to country, but we plan to be part of
the solution and help influence powerful change” .
13
Meat, especially beef, has a large carbon footprint, and meeting growing meat
demand is not achievable within Planetary Boundaries (FAIRR, 2019 ). An analysis
14
by TrueValue Labs suggests that McDonald’s significantly underreports on its
15
carbon footprint. And deforestation is also a serious issue in McDonald’s supply
chain, not just in meat but in soy too. This suggests that the health effects might
be easier to solve than the environmental effects.
3.4. Which of the SDG's (if any) does the company help achieve?
Which negative SDG-exposure (if any) does the company have?
Given the above mentioned negative externalities, McDonald’s has quite negative
exposures to SDGs 3 (health & well-being), 12 (sustainable production and
consumption), 13 (climate action), 14 (life below water), and 15 (life on land). The
company paints a different picture though. It dedicates a separate part of its
website to its contributions to the SDGs , but focuses squarely on how the
16
company can make a positive contribution. There is no mention of its negative
exposures, which is awkward, and undercuts the credibility of its commitments.
Table 4 outlines how McDonald’s believes it makes a positive impact on 6 of the
17 SDGs.
http://www.climateaction.org/news/all-mcdonalds-packaging-will-be-sustainable-by-2025
12
https://corporate.mcdonalds.com/corpmcd/scale-for-good/packaging-and-recycling.html
13
FAIRR, 2019, Managing environmental risks in meat and dairy supply chains
14
TrueValue Labs, January 2019, Research Brief McDonald’s Corporation
15
https://corporate.mcdonalds.com/corpmcd/scale-for-good/using-our-scale-for-good/un-sustainable-development-goals.html
16
| Erasmus Platform for Sustainable Value Creation16
TABLE 4: SDG CONTRIBUTION CLAIMS BY MCDONALD’S
Source: authors’ analysis
There are clearly areas where McDonald’s can make a significant contribution, and
such efforts should be applauded. But it is mostly about making negative impact
less negative – and with mixed levels of credibility and commitment. By its sole
attention to positives, McDonald’s makes this look like corporate propaganda and
SDG-washing. This also raises the question of how they spend their lobbying
money.
SDG
Contributing to..
Credibility
Explanation
2. Zero hunger
Universal access to safe
and nutritious food
Low
Its food is cheap, but
not that cheap that it
feeds people who are
starving; yes it’s safe,
but not very nutritious
8. Decent work &
economic growth
Reducing
unemployment and
developing useful skills
Medium
Does offer
opportunities, but at
low wages
12. Responsible
production and
consumption
Sourcing food and
packing responsibly
Medium
So far negative, but
serious initiatives
being taken
13. Climate action
Help reduce climate
change impact
Low
Very negative
footprint from meat
and seems to be
lower priority than
packaging
15. Life on land
Eliminate deforestation
from its supply chain
Medium
This could result in a
serious reduction of a
negative impact. And
the company has
strong incentives to
reduce risk here.
17. Partnerships
for the goals
Partner with
stakeholders to tackle
global issues
Low
How serious is the
company on the
above?
| Erasmus Platform for Sustainable Value Creation17
3.5. To what extent can the company's impact be measured? Does the
company report on its impact? How can its reporting be
improved?
McDonald’s does not report on its impact, which makes it very hard to measure.
Reporting could be vastly improved by doing a TruePrice or Future Fit analysis.
3.6. a. Thresholds: how does the company perform versus the
planetary boundaries?
In other words: is the firm’s sustainability performance good enough? It is hard to
tell and the company does not indicate how big its contribution is versus how big
it should be.
•
On health, how many lives does the company touch and how much less health
does it make those people on average?
•
On the environmental side, what are the firm’s carbon emissions and impact on
biodiversity? How much can it do to reduce that?
In sum, the basic data are missing. The company could take inspiration from Novo
Nordisk, which recently launched its Future Fit analysis.
MATERIAL ISSUES
Not all sustainability issues are equally important (‘material’) from an investment
perspective. It is important to identify material sustainability issues, which may
differ across companies and industries (Khan et al., 2016).
3.6. b. What are the most material ESG factors? I.e., what issues are
most critical to the success of the company's business model?
The below matrix discusses for each of the most material ESG factors (1) how the
company performs on it; (2) whether the company derives a competitive
(dis)advantage from it; (3) how they might affect the value drivers.
| Erasmus Platform for Sustainable Value Creation18
TABLE 5: MOST MATERIAL ISSUES FOR MCDONALD’S & VALUE DRIVER IMPACT
Source: authors’ analysis
McDonald’s did its most recent materiality analysis back in 2014. They don’t
provide a materiality matrix but do give their five priorities :
17
•
Climate action;
•
Beef sustainability;
•
Packaging and recycling;
•
Commitment to families;
•
Youth opportunity.
Material issue
Performance
Competitive
edge?
Impact on value
drivers?
Product quality
& customer
health
See the externalities section.
Strong in terms of reliability and
safety as the company has a
rigorous food control system.
However, it is weak in terms of
nutritional health. Did try to
improve this but not welcomed
by customers
They might have
an edge versus
peers when the
industry is forced
to change – i.e.
suffer less
The health factor
could be a very
serious drag on
sales and margins,
and could
potentially kill their
business model
Human capital
Efficient and standardized
personnel trainings; known for
offering career opportunities to
the young and inexperienced;
praised on Glassdoor and
Indeed. But, turnover is high and
people make long hours. The
company only recently stopped
lobbying against a $15 minimum
wage in the US.
Yes, they do
seem to have an
edge over peers
Higher margins
Environmental
footprint
See the externalities section:
hard to call
Hard to call
Higher cost of
capital and
potentially lower
margins & lower
growth
Brand
management
Strong performance
Yes
Higher margins
Sustainable
supply chain &
waste from
packaging
See the externalities section:
hard to call
Hard to call
Higher cost of
capital and
potentially lower
margins & lower
growth
See: https://corporate.mcdonalds.com/corpmcd/scale-for-good/using-our-scale-for-good.html
17
| Erasmus Platform for Sustainable Value Creation19
Notably lacking among those priorities is the nutritional value of its products.
SUSTAINABILITY REPORTING
Integrated Reporting (<IR>) aims to improve financial reporting by giving a more
complete picture of corporate performance, including non-financial or pre-
financial performance.
3.7. How do you assess the company’s non-financial reporting? And
its approach to sustainability? How credible is it?!
The company’s sustainability reporting is limited. It published three supply-chain
sustainability reports (coffee, beef, and packaging). However, the main focus of
the reports is on providing anecdotal evidence on its best practices rather than
disclosing the general sustainability performance and not-so-good practices.
McDonald’s does have sustainability goals, but there is little data and little
information on the precise actions to achieve the goals.
In contrast, Philips’s sustainability reporting is very advanced. The company has a
long tradition in integrated reporting (since 2008) and sustainability reporting
(since 1998). Notable features in its 2017 annual report include targets on circular
economy sales, and the target of 3bn lives improved – making it one of the few
companies that reports on impact. The report meets most of the seven guiding
principles of an integrated report – except conciseness. It also has all the eight
elements of an integrated report. Philips also has an environmental profit & loss
(EP&L) statement.
3.8. Does the company (claim to) do Integrated Reporting (<IR>)?
No. This is unlike Philips, which has been doing <IR> since 2008.
3.9. To what extent do you see the seven principles of <IR> reflected
in the company’s reporting? Please fill out the following matrix
(see also Table 6.3 in Chapter 6):
Unlike Philips, McDonald’s does not score well on the principles of integrated
reporting:
TABLE 7: PRINCIPLES OF <IR> FOR MCDONALD’S AND PHILIPS
Principle
Degree of application for
McDonald's
Degree of application for
Philips
Strategic focus & future
orientation
~ reasonable
√ describe the path to value
creation; ‘roadmap to win’
| Erasmus Platform for Sustainable Value Creation20
Source: authors’ analysis
Unfortunately, McDonald’s reporting level seems more typical of listed companies
than that of Philips.
4. Strategy
Ideally, a company’s strategy is aimed at long-term value creation (see
Schoenmaker and Schramade, 2019, Chapter 5).
4.1. How would you describe the strategy of the company?
Unfortunately, the company does not explain its strategy in terms of the five
elements of a strategy as defined by Hambrick & Fredrickson (2005): arenas,
staging, vehicles, differentiators and economic logic. But the company does have
Connectivity of information
~ some references given
√ there is quite a bit of cross-
referencing
Stakeholder relationships
~ some stakeholder
dialogues mentioned but no
overview of stakeholder
relations
√ Philips explicitly refers to its
stakeholders and to its multi-
stakeholder projects
Materiality
~ some priorities given, but
not sufficiently. No materiality
matrix
√ Philips reports a materiality
matrix that rates quite a few E,
S, and G issues on business
impact versus importance to
stakeholders
Conciseness
√ perhaps too concise
X report is still hundreds of
pages long
Reliability and
completeness
X too anecdotal, cannot get
the big picture
~ Philips reports ‘sustainability
statements’, which includes
references to stakeholders; a
materiality matrix, as well as
data and targets on items
such as lives improved,
circular revenues, carbon
footprint, waste recycling and
supplier sustainability.
However, it is not very clear
how that affects financial
results
Consistency and
comparability
X no data
√ comparability of data versus
other years is good, but
comparability with other
companies is limited
| Erasmus Platform for Sustainable Value Creation21
a clear growth strategy . In this ‘Velocity Growth Plan’ it outlines how it aims to
18
retain customers by extending the range of services; regain customers by
providing better quality food and service; and convert occasional to committed
customers. This is envisaged to be achieved through: healthier food, digitalization,
and sustainability efforts. McDonald’s shifts towards greater transparency and a
more sustainable supply chain are encouraging. The ‘Scale for Good’ initiative
includes sustainable supply chain, fiber packaging and recycling, healthier food for
kids, and investments in people.
Leleux and Van der Kaaij (2018) describe how the arrival of new CEO Steve
Easterbrook in March 2015 meant a landmark change for the company (‘How
McDonald’s got its mojo back’). In the quest to improve brand relevance, the
company’s chief supply chain officer became responsible for sustainability. This
shows that sustainability can play an important role in a company transformation –
through its contribution to the relevance of the brand.
4.2. To what extent does that strategy take into account the
company’s most material ESG issues?
To a large extent it does. The above strategic choices suggest that McDonald’s
management understand their predicament very well, at least regarding the
environmental side of their negative impact. Unfortunately, it is not yet visible in
quantified targets and reporting.
4.3. Is the strategy consistent with the company’s purpose? Please
explain.
McDonald’s aims to be its customers’ favorite place and way to eat and drink
(Mission statement 2013). The new strategy clearly relates to that (retaining &
regaining customers). The link to sustainability is better captured by the company’s
intention to make people “feel good about visiting us”, which includes the quality
of food, customer experience, and even hints at its impact on the world. Indeed,
McDonald’s wants to attract customers by providing better food and services and
building the image of a responsible company. However, it still looks like SDG
washing. The big question is how thoroughly McDonald’s will execute on this
strategy, i.e. by setting and meeting measurable and ambitious targets, rather than
just make some cosmetic changes.
4.4. What does long-term value creation look like? What are the best
KPIs for it?
Long-term value creation for all stakeholders means decent returns on F, E and S:
•
F: ROIC above the cost of capital
https://corporate.mcdonalds.com/corpmcd/about-us/our-growth-strategy.html
18
| Erasmus Platform for Sustainable Value Creation22
•
E: avoid harm and ideally improve by providing solutions to others in reducing
their harm. Possible KPIs include emissions; emissions reductions; % circular
sales
•
S: similar to E in terms of avoiding harm and providing solutions. KPIs: health
effects; nutritional content of its food; sugar, salt and fat content; NPS;
employee satisfaction.
In sum, there are not yet clear criteria for value creation in terms of E and S, but
KPIs to proxy them do exist. Unfortunately, McDonald’s does not disclose them.
4.5. What does management compensation look like? To what extent
does management have long-term incentives? And are those
incentives aligned with long-term value creation?
Management compensation seems based purely on stock and stock options.
Claw-back provisions and non-financial metrics do not seem to be in place.
Hence, long-term alignment seems limited.
4.6. How does the company communicate its long-term value
creation with shareholders and stakeholders?
The company holds numerous stakeholder dialogues, but investor
communications are more traditionally oriented on short-term profitability.
5. Value drivers – part 2
In Schramade (2016) it is described how analysts can make adjustments to their
value driver assumptions based on how the company’s most material ESG issues
affect its competitive position.
5.1. Given all of the above questions & their answers, how do you rate
the effect of material sustainability issues on the value drivers
going forward? Per value driver, please indicate whether you see
a positive, negative or neutral effect – and please explain why.
The value drivers are negatively affected by material ESG issues:
!
TABLE 7: VALUE DRIVER ASSESSMENT FOR MCDONALD’S
Value driver
Overall adjustment
Versus peers
Explanation
Sales
growth
negative
positive
Healthier diets / taxes
on unhealth food will
probably hurt
demand for fast food
chains. However,
McDonald’s might
enjoy an advantage
versus direct peers.
| Erasmus Platform for Sustainable Value Creation23
Source: authors' analysis"
These effects do not seem to be factored into current share prices.
5.2. How would this affect your valuation of the company?
As we put Table 7’s assessment into numbers, we get the following results:
TABLE 7: VALUE DRIVER ADJUSTMENTS FOR MCDONALD’S
Source: authors' analysis
Admittedly, these are still point estimates, and one could better address the high
levels of uncertainty with scenario analyses on the internalization of externalities,
which could look like this:
Profitability
negative
positive
Adjustment to a
healthier diet is hard
to avoid and will likely
result in higher costs,
lower margins and
negative scale effects.
Capital
negative
positive
Cost of capital will go
up as sustainability
risks begin to
materialize in full
force. Again, this will
likely hurt peers even
more.
Value driver
McDonald’s before
ESG assessment
McDonald’s after
ESG assessment
Adjustment
Sales
growth
3%
2%
-100bps
Margins
43%
40%
-300bps
Cost of capital
6.2%
7.0%
+80bps
DCF value
$184
$129
-$55 (-30%)
| Erasmus Platform for Sustainable Value Creation24
GRAPH 1: INTERNALIZATION SCENARIOS
$
Source: authors’ analysis
The next step would then be to add the following to each of these scenarios:
•
An assessment of McDonald’s ability to handle the resulting situations;
•
value driver implications;
•
probabilities (including joint probabilities!)
But it goes beyond the scope of this case study to conduct a full scenario analysis.
6. Investment conclusions
6.1. How well prepared do you think McDonald's is for the transition
to a more sustainable economic model?
It is hard to answer this question. On the one hand, McDonald’s faces serious
threats from its negative health and environmental externalities. And the
company’s reporting does not give sufficient information to quantify these threats,
nor on the company’s targets and incentives. On the other hand, the company
does seem to have significant optionality in handling some of these issues – more
than its peers or Air France-KLM for example.
6.2. How attractive do you find the company as an investment? Please
explain and refer to your above answers.
McDonald’s is widely viewed as an attractive investment case among financial
analysts, who like the high margins of big brands in ‘winner takes all’ markets. The
typical sell-side analyst report focuses on current issues like store modernization,
and arrives at a target price by multiplying this year’s expected earnings with a
| Erasmus Platform for Sustainable Value Creation25
multiple of say 25 because that happens to be the average historical trading
multiple. However, a more long term oriented analysis like ours suggests that risks
are much higher than typically anticipated.
6.3. What did you find most surprising when answering the above
questions?
The student who analyzed McDonald’s during the 2018 Sustainable Finance
course in the RSM Master’s program said the following:
“Although McDonald’s is trying to become more sustainable, there is a
contradiction between its strategy and the way the company is perceived
(unhealthy, deep-fried, junk food). It is surprising that the company is trying to
improve its image while at the same time stay true to its roots (burgers). The last
attempt to make McDonald’s healthier resulted in lower sales. I am curious to see
how successful the new strategy will be.”
6.4. If you were to engage with the firm, what topics would you
address?
Key topics to address would be externalities and the improvement of reporting.
On externalities, it would be good to understand their views on the likelihood and
pace of externalization processes (views on consumer preferences; regulation;
need for healthier food; carbon pricing etc.?) – and were they to dismiss those
processes, that would be a serious red flag. On reporting, we’d welcome much
more granularity on impact and the contributions to the SDGs: how big are those
in both positive and negative terms? What is their view on sustainability
thresholds? And could they please give historical data and quantitative targets on
your most material issues?
And how accountable is top management given the lack of targets and data on
key issues?
In addition, data on comparable firms would be most welcome, but ESG data
providers or sell-side research would be the more logical source of such
comparisons.
| Erasmus Platform for Sustainable Value Creation26
McDonald’s is an interesting case because of the contrast between its strong
financial performance (so far) and weak performance on externalities. Were those
externalities to be internalized, McDonald’s financial performance would likely
suffer significantly. The long-term viability of its business model would also
become questionable. Unfortunately, reporting is so limited that we lack the data
to make a high conviction assessment of the company’s transition preparedness.
This is a serious disappointment, and represents a systematic shortcoming of
corporate reporting practices.
On the website of the Erasmus Platform for Sustainable Value Creation (https://
www.rsm.nl/erasmus-platform-for-sustainable-value-creation/home/) we publish
similar cases for other companies. This allows for comparing McDonald’s with
companies in different predicaments. Like the other cases in this series, this one
highlights the need for fundamental analysis (that is, going well beyond ESG
ratings) to properly assess a company’s transition preparedness, which we deem
the essence of corporate sustainability.
5
Conclusions and
reflections
| Erasmus Platform for Sustainable Value Creation27
Eccles, R.G., D. Saltzman (2011). Achieving sustainability through integrated reporting. Stanford "
Social Innovation Review, 59.
Hambrick, D. C., and J.W. Fredrickson (2005). Are you sure you have a strategy?. Academy of "
Management Perspectives, 19(4), 51-62.
Johnson, M., C. Christensen and H. Kagermann (2008), ‘Reinventing your business model’, "
Harvard Business Review, 86(12): 57-68.
Khan, M., G. Serafeim and A. Yoon (2016), ‘Corporate Sustainability: First Evidence on Materiality’, "
Accounting Review, 91(6): 1697-1724.
Koller, T., M. Goedhart, and D. Wessels, D. (2015). Valuation: Measuring and managing the value of "
companies, 6th edn, John Wiley & Sons, New York.
Steffen, W., K. Richardson, J. Rockström, S. Cornell, I. Fetzer, E. Bennett, R. Biggs, S. Carpenter, W. "
de Vries, C. de Wit, C. Folke, D. Gerten, J. Heinke, G. Mace, L. Persson, V. Ramanathan, B. "
Reyers and S. Sörlinet (2015), ‘Planetary boundaries: Guiding human development on a "
changing planet’, Science 347(6223): 736-47.
Schoenmaker, D. and W. Schramade (2019), Principles of Sustainable Finance, Oxford University "
Press, Oxford.
Schramade, W., and D. Schoenmaker (2018), Royal Philips: a sustainable finance case study. "
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Schramade, W. (2016), ‘Integrating ESG into valuation models and investment decisions: the "
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Companies and Investors’, Journal of Applied Corporate Finance, 29(2): 87-99.
6
References
| Erasmus Platform for Sustainable Value Creation28
