McDonald’s: A Bit Pricey But Very Interesting

Summary:

• McDonald’s Corporation is a dividend-paying company with a long history of growth and strong returns for investors.
• The company’s revenues have been stagnant in recent years, but it has shown impressive growth in net income and diluted EPS.
• McDonald’s has consistently increased its dividend payment and offers a sustainable payout ratio, making it an interesting investment option.
• The company just announced an increase on royalties of 25% for new franchisees, which should add revenue over time.

When it comes to dividend-paying companies with a very long history of growth, few compare with McDonald’s Corporation (NYSE:MCD). The company is known for its burgers, fries, and shakes, although broken shake machines are a long-running Internet meme. I must confess that I’ve visited more than one store for a shake, only to be turned away. Regardless, the company is one of those seemingly boring investments that has provided investors with strong returns for decades.

Harry Sonneborn told Ray Kroc, the man who largely built the company after buying it from the McDonald brothers, that McDonald’s was not in the burger business, but rather in the real estate business. A lucrative business this has been, for sure. Today, McDonald’s runs 38,000 stores in more than 100 countries. I can vouch for the international nature of the business, as I’ve frequented them in multiple countries.

Franchisees pay McDonald’s healthy rents to operate about 93% of these stores, providing a massive infusion of cash for the company’s bottom line. Additionally, the company charges its franchisees a royalty that’s based on a percentage of sales. Indeed, as of September 22, the company has just decided to raise its royalty fee by 25% to 5% of sales, although this increase will only apply to new franchisees. This should provide additional revenue to its shareholders, especially as older franchisees hand over the reins of their stores, and it becomes effective on January 1, 2024.

Finances

Revenues for MCD have been fairly stagnant over the past several years, and they currently stand at just below $23 billion for the last annual report. This is down from more than $28 billion in 2013. Global comparable sales just increased by 11.7% year over year according to the latest quarterly report. This included a 10.3% increase among its U.S. stores. This is an impressive growth rate.

Net income for the most recent quarter came in at $2.31 billion, compared to $1.19 billion for the same quarter the previous year. Quarterly earnings can be a bit choppy, so it is important not to read too much into one quarter. Annual reports can provide a better idea of how stable a business is. McDonald’s does not disappoint here. While there has not been a steady annual growth in net income, this number has generally ranged between $4.5 billion and $6.1 billion annually. The outlier was 2021, which showed a $7.5 billion net income for the year. The last twelve months have provided nearly $8 billion in net income according to Seeking Alpha, which exceeds any annual total over the past decade.

McDonald’s has seen its diluted EPS vary from a low of $4.80 to a high of $10.04 over the past decade. The current year appears as though it might come in close to the higher number. Over the past decade, the company bought back a little more than a quarter of its shares, although most of this took place before the pandemic. Buybacks have not been nearly as aggressive since 2019. However, the lower share count is definitely a benefit for investors, as there are fewer investors to share the profits.

Dividends

McDonald’s has increased its dividend payment for 46 consecutive years. Investors can expect to see the latest dividend increase next month, if previous history is any indication. The current payout is $1.52 per quarter, or $6.08 per year per share. The growth rate for the past five years is sitting at 8.52%, and it will be interesting to see if the upcoming raise will come in close to this number. If it does, that should provide a glimpse into management’s forward thinking.

The yield is not terribly impressive at 2.24%, but the growth is. Many times, higher yields do not grow, and they can even see cuts or suspensions. Those with a long time horizon can actually benefit from lower yields like the one offered by McDonald’s, as long as it continues to grow. Depending upon the EPS for a given year, the payout ratio has generally fluctuated between 50% and 70%, which would make this dividend appear fairly sustainable.

Current Value

McDonald’s Corporation is currently trading at a 23.4 multiple on a forward-looking basis. That is not a screaming value. However, there are a few factors that make it interesting. First is the company’s popularity. Kids around the world (and by association, their parents) love eating at McDonald’s. Few brands are as iconic as the golden arches logo. Also, the company should be fairly recession resistant. People need to eat, and in an economic downturn, McDonald’s will likely be hurt less than a more expensive restaurant that sells high-priced steaks. The company has increased its prices in recent years (it’s almost $10 for a value meal!), but that has not hurt sales.

Because McDonald’s frequently owns the properties and rents them out to franchisees, the company also has the possibility of imposing periodic rent increases. This, along with the upcoming royalty increase should provide a growing stream of cash. Additionally, McDonald’s is currently sitting about 10% off its recent highs (nearly $300 to $273 per share as I write this on September 22). These facts, along with a growing revenue stream for income-focused investors by way of a growing dividend, make the company very interesting.

As noted above, when MCD announces its fourth-quarter dividend, there should be a better idea of how optimistic the company is going forward. A raise in the 8% to 10% range would be a good sign, while one in the 3%-5% range might be cause for a bit of concern. Overall, however, I find the company very interesting at this point.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.

I am not an investment professional. The preceding is intended for informational and educational purposes. Please make sure to perform due diligence before investing in equities, as losses up to all capital invested can occur.

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