Mr. Buffett and his cash machine Berkshire Hathaway Inc. (NYSE:BRK-B) are on a constant search for cash-rich companies. With $43 billion (and counting) in cash, Berkshire has the time and resources to find the next iconic company to join The Coca-Cola Company (NYSE:KO) and American Express in its portfolio. But Berkshire has the luxury of being picky. It only chooses companies that fit its strict guidelines perfectly. The ideal buyout candidate must be able to generate a consistent cash flow stream, it must be a big, dominant player in its market, and it must have large enough margins of profitability. Above all, the company must always act in the best interests of shareholders – employ a share buyback program, pay hefty dividends and try to never be involved in silly, expensive acquisitions. There are only a handful of companies that meet these strict conditions. Heinz, Berkshire’s recent acquisition, passed all the above tests rather easily. But the big question is, which other big players does Mr. Buffett plan to buy before he finally retires as CEO of Berkshire?
McDonald’s seems to present many of the traits that Berkshire is looking for. In particular:
1. McDonald’s Corporation (NYSE:MCD) has a fabulous track record of consistent earnings. Back in 2007, the company earned net income of $2.4 billion. If you fast forward six years (and many more burgers), the company has raked in net income of $5.4 billion. That’s an amazing average annual growth of 20% in net income. Even Coca Cola, the most branded consumer product in American history, has been able to increase its net income by “only” 10% annually. This makes McDonald’s achievement extremely impressive.
2. McDonald’s is giving back to its shareholders. The company has spent billions of dollars buying back its own shares and paying dividends to shareholders. McDonald’s Corporation (NYSE:MCD) share count is currently at a billion, down from 1.2 billion six years ago. Not only that, but at the same time the dividend rate has been increasing at an annual clip of 13%. In other words, the company’s shareholders are earning more for less. Even Coca Cola, Berkshire’s cornerstone company, has been increasing its annual dividend by only 8% each year.
3. McDonald’s is an iconic brand. Everyone knows what it is, and Ronald, the company’s famous clown, is one of the most recognized brands in the history of marketing. In fact, McDonald’s Corporation (NYSE:MCD) brand recognition is almost similar to that of Coke’s, according to a recent Forbes survey.
4. The company is able to present mouth – watering margins. With net profit margins and operating margins of 20% and 30%, respectively, the company easily qualifies as a member of the Berkshire Hathaway club. Only Coca Cola, with its branded sugar- carbonated water, is able to obtain similar margins to those of McDonald’s Corporation (NYSE:MCD). Except for Coke, there isn’t a single company in Berkshire’s portfolio with such margins.
Yet, Mr. Buffett hasn’t bought a single share of McDonald’s over the years.
Why Not?
It’s a mystery indeed. Yet, I’ll try and provide two quick suggestions as to why the Oracle of Omaha left McDonald’s untouched.
1. The company operates in a franchise business model. More than 90% of the company’s stores are externally managed by franchisees and not directly by the company. Buffett has never invested in a company with such a massive franchise model. Management, as capable as it may be, will never have full control over all of different stores and franchisees.
2. McDonald’s doesn’t really have a strong economic moat, which is a must for any of Buffett’s investments. Think about it for a second. Unlike American Express, nothing of McDonald’s is proprietary or patent-protected. Unlike Coca Cola, McDonald’s doesn’t have a secret hidden recipe in a safe. It makes very tasty, cheap burgers, but other rivals know how to make cheap and tasty burgers as well. Put simply, McDonald’s has a great brand, but not such a great economic moat.
The Foolish Conclusion
McDonald’s Corporation (NYSE:MCD) is a fantastic company by all means – it’s a branded icon, it’s a cash gushing machine, and it’s very friendly to its shareholders. But more likely than not, Mr. Buffett, loyal to his strict rules, will never ever invest in in. He might eat a burger every now and then, though.
The article Will Buffett Ever Buy McDonald’s? originally appeared on Fool.com and is written by Shmulik Karpf.
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