Fredric,
being a big Buffett fan, as soon as I saw the DQ news, rushed over to EDGAR to see if my results made a $27 per share offer look good. To my delight, the slowly growing but predictable free cash flow indeed seemed to make $27 look like a bargain. So this gave me more confidence that I'm crunching the numbers the way he would.
Thanks for the article. She started off great, and I was agreeing with everything she said, like:
"Consequently, the company has little in the way of capital expenditures and a lot in the way of free cash flow (the cash available for further investment, dividends, share buybacks, and so on, net of the capital spending necessary to run the business). The more free cash flow, as a percentage of a company's total cash flow, the more flexibility and the less financial risk the company has."
and:
"Now imagine a company that produces all this excess cash, but remains fiscally conservative because it doesn't have to lever its returns. Its returns on equity (ROE) already top 20% with only a modest amount of debt. Instead, decent profit margins (net income/sales) combined with high asset turnover (sales/assets) rather than financial leverage drive this company's returns. That's the story of Dairy Queen's profitability."
Very insightful analysis. But then she falls back on the old P/E crutch, completely contradicting her earlier statements:
"A 15 P/E seems a little pricey relative to the company's projected earnings growth rate of 8%. The payback period on this combination of P/E and earnings growth rate is about 10 years, meaning that it will take 10 years to accumulate $15 per share of earnings-a profit of 100% on the $15 Berkshire initially pays for each dollar of Dairy Queen's earnings (the 15 P/E). That 100% cumulative profit translates into an annualized compound rate of return of 7.2%. "
This was very disappointing to read. It's true that for DQ, depreciation and capital spending basically cancel out, making earnings a good proxy for free cash flow. But this is very often not the case (just look at MCD!), making P/E ratios useless: I beleive that FCF, not earnings, are the true economic return from a business. She believes it too. So why did she fall back on the smoke and mirrors to do her valuation? She added up every year's earnings, assuming an 8% growth rate, until in year 10, $15 had accumulated. How is this a 100% profit? It looks like break-even to me. And what about the effects of inflation? She doesn't discount the future earnings, which are worth less in today's dollars!
So in summary, I agreed with her analysis, but choked on her valuation. But her excellent analysis points out the hidden value of MCD: When the music stops, we'd better have a chair, because cash is going to gush out in the billions. It's all right there in the Cash Flow Statement - when they slow down the cap spending, where is all that cash going to go? I think into our pockets! (Actually, I haven't bought in yet, but you know what I mean! <g>)
Andrew |
