McDonald’s Stock: Freshly Minted Dividend Adds Flavor

Summary:

• McDonald’s Corporation announces a 10% increase in its quarterly dividend per share, marking the 2nd consecutive year of a 10% increase.
• This marks the company’s 47th consecutive dividend increase, underlining its ability to operate successfully in almost any environment.
• Relative YTD underperformance and just-increased dividend make McDonald’s stock a buy here for the long-term.

McDonald’s Corporation (NYSE:NYSE:MCD) has just announced its annual dividend increase as Seeking Alpha has covered here. I love this time of the year, as many stocks I own and follow typically announce their dividend increases. Altria Group, Inc. (MO) and Microsoft Corporation (MSFT) are some other recent examples.

A few quick highlights from McDonald’s dividend increase:

• The new quarterly dividend per share is $1.67, up another healthy 10% from the previous $1.52 cents a share. This marks the 2nd consecutive year that McDonald’s has announced a (~) 10% increase.
• The new dividend will be paid to investors on 12/15/2023, with an ex-dividend date of 11/30/2023.
• According to its website, McDonald’s has increased its dividends each year since 1976. The dividends have followed the quarterly cycle since 2008, before which it was on a yearly pattern. That makes it 47 consecutive years of dividend increases.

This article was written when McDonald’s announced its dividend increase in 2022 and this one was written in 2014 after the company’s increase back then. For ease of comparison, this article follows the same general layout as the 2022 and 2014 articles. Let us get into the details.

New Dividend and Yield

The new annual dividend of $6.68 gives McDonald’s a current yield of 2.60%, up slightly from the 2.47% after 2022’s dividend increase. This is due to the fact that while the dividend has jumped up 10%, the stock has only gone up 5% in the same timespan, nudging the yield up a little. A more interesting and impressive fact is that just before 2014’s dividend increase, McDonald’s was paying $3.24/share. In about 10 years, the dividend has more than doubled.

While that sounds impressive, is the company really making more money or is just paying through expanding payout ratios? Let’s find out.

Payout Ratio

McDonald’s had an EPS based payout ratio of 61% after both 2022 and 2014 dividend increases. After this year’s 10% dividend increase, the payout ratio has actually gone down to about 58% based on forward EPS of $11.58. As a long-time MCD holder, this comforts me in two ways:

(a) the company still has plenty of room for future dividend increases

(b) the company knows how to operate better as it gets older each year.

Over the years, I’ve started using Free Cash Flow [FCF] over EPS as a better indicator of dividend strength, due to the fact that EPS may get adversely affected by one-offs.

• McDonald’s has 728.76 million shares at the end of the June quarter.
• Based on the new quarterly dividend of $1.67/share, the company needs $1.217 billion in quarterly FCF to cover its dividends. That is, 728.76 million shares times $1.67/share.
• McDonald’s average quarterly FCF over the last 5 years stands at $1.40 billion, which gives a FCF-based payout ratio of 86%. That is a little concerning.
• Giving the company the benefit of doubt due to its pedigree, if we remove the -$518 million in June 2020 (peak COVID) quarter, McDonald’s has averaged a FCF of $1.63 billion in the 12 quarters since, which equates to a more comfortable payout ratio of 74%. But let’s dig a bit deeper. The June 2022 quarter had just $180 million in FCF, which was a direct result of the company’s move to close and/or rebrand its stores in Ukraine and Russia due to the unfortunate War. Ignoring that quarter, we get $1.76 billion in quarterly FCF in the 11 quarters since COVID lows. That results in a payout ratio of 68%. Please note that I don’t give the benefit of doubt to the companies easily. But McDonald’s deserves it in more ways than one due to its quality as a company and its reliability as a stock.

To summarize this section, I believe both EPS and FCF payout ratios look comfortable enough here. The FCF-based payout ratio being higher is reflective of the fact that McDonald’s tends to purchase new properties on a regular basis and this affects FCF more than EPS.

Five-Year Dividend Growth Rate

As the table below shows, this is the second-highest dividend increase in terms of percentage in the last 5 years. The five-year dividend growth average of 7.59% is down from the 8.59% last year and 9.16% back in 2014.

Once again, adjusting for the COVID lows, McDonald’s is doing better with the 5-year average dividend growth rate (ignoring the 2020 raise and including 2017’s instead) being a more impressive 10.60%.

Extrapolation

As always, this article includes an extrapolation on what the future increases might look like with reasonable assumptions. The table below assumes a 7% annual dividend increase for the first 5 years and 5% for the next five. The yield on cost is likely to double conservatively from here, especially given the payout ratios established above.

Forward Thoughts and Conclusion

While there are some risks to be aware of like the potential change in overtime pay rules and consumer health (no pun intended), McDonald’s has some of the best things a business could ask for in its favor: brand recognition and pricing power. The pricing power is not only flexed against customers but also the franchisees. For those who may not be familiar with the company’s history (or the movie, The Founder), McDonald’s is perhaps the most under-cover real estate company in the world and their confidence in the quality of their locations shows up in the decision to hike franchise royalty fee from 4% to 5%.

From a shareholders perspective, in addition to rewarding with dividend increases, McDonald’s has been disciplined about its share structure as well. Over the last 5 years, shares outstanding has gone down by 5%, which may not seem like a lot. But when you place numbers into context, you will realize the long-term significance of it. For example, over the next 12 months, the 39 million shares retired in the last 5-year will be saving the company $260 million (in the form of dividends that don’t need to be paid at $6.68/share).

At a forward multiple of 22, McDonald’s stock may appear fully valued, but if history is anything to go by, this stock is rarely cheap, as evidenced by the 5-year average multiple being 28.54. With its relative underperformance YTD and trading closer to 52-week lows than highs, I rate MCD stock a Buy here on the back of the just-announced, larger than expected, dividend increase.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of MCD, MO, MSFT either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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