Updated on January 24th, 2019 by Nate Parsh
Every year, we review each of the 53 Dividend Aristocrats, the group of companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
Next up is fast food giant McDonald’s (MCD). McDonald’s paid its first dividend in 1976, and has increased it every year since. The company has now increased its dividend for more than four decades. You can learn more about McDonald’s dividend history and current dividend safety in the following video:
McDonald’s has implemented a successful turnaround, through new menu offerings, remodeled restaurants, and a greater push to franchise restaurants. Put together, these efforts have done the trick. McDonald’s is a high-quality Dividend Aristocrat feeding shareholders with dividend growth.
McDonald’s was founded in 1954, by Ray Kroc and his partners, Dick and Mac McDonald. Together, they formed the McDonald’s System Inc. In 1960, Kroc bought the exclusive rights to the McDonald’s name.
With a market cap of almost $141 billion, McDonald’s is the largest publicly-traded fast food company in the world. It operates over 36,000 locations, in more than 100 countries around the world. The company generates over $24 billion in annual sales.
Revenues come primarily from franchise fees. McDonald’s has accelerated its franchising over the past several years. While this effort has led to year-over-year revenue declines for the past few quarters, it has allowed McDonald’s to expand its profitability. The company’s most recent quarter showed a sales decline of 6.6%, to $5.4 billion. Global same-store-sales, however, increased 4.2%, above consensus estimates of 3.7% growth. Earnings-per-share increased 19% to $2.10. Profit growth was attributed to higher franchise fees, a lower tax rate, and share repurchases.
Past years were difficult for McDonald’s. Earnings-per-share declined more than 13% from 2013 to 2014. It wasn’t until 2016 that the company produced earnings-per-share results that were above 2013’s total. But now that McDonald’s has gotten back on track, its momentum should continue.
McDonald’s performance has improved, due in large part to the strategic initiatives put in place to restore growth. These initiatives are working well, and put McDonald’s in a good position to continue growth moving forward.
First, McDonald’s announced new menu offerings, including all-day breakfast, and the McPick 2 promotions. A renewed focus on providing value to customers has helped restore traffic. U.S. same-store-sales were up 2.4% in the third quarter, helped by higher menu prices and the increased traffic. International markets have shown even more growth. Led by the U.K., Australia and France, ‘international lead markets’ saw growth of 5.4%. High growth markets had a 4.6% increase in same-store-sales, well above the 2.8% growth analysts were looking for.
In addition, McDonald’s underwent a new wave of refranchising. Just a few years ago, a majority of McDonald’s revenue (62%) came from company-owned stores. But McDonald’s has flipped this around, and in the most recent quarter, more than 53% of revenues came from franchised restaurants. More than 4,000 restaurants have been refranchised over the past two years. McDonald’s has a target of refranchsing nearly 95% of its restaurants over the long run.
The company expects to open at least 2,000 new stores over the next five years. Through the end of the third quarter, 375 new McDonald’s restaurants have already been opened in 2018. McDonald’s expects to earn $7.60 per share in 2018, which would be 14.1% growth from the previous year. This would be another year of strong earnings growth. We estimate that the company can grow earnings-per-share at a rate of 5.9% per year through 2024.
Competitive Advantages & Recession Performance
McDonald’s enjoys several competitive advantages that separate it from its industry peers.
First, it is the largest publicly-traded fast food company in the world. It has enormous scale, which allows it to keep prices low.
And, it has a very strong brand. According to Forbes, McDonald’s is the #7 most-valuable brand in the world, worth over $37 billion.
One of the big reasons why McDonald’s continues to increase its dividend year in, and year out, is because it has a defensive business model.
When the economy takes a downturn, consumers tighten their belts, particularly when it comes to dining. Rather than go to higher-priced sit-down restaurants, consumers will often shift down to fast food during a recession.
It seems strange, but from this perspective, McDonald’s actually benefits from recessions. For evidence of this, its earnings-per-share during the Great Recession are shown below:
- 2007 earnings-per-share of $2.91
- 2008 earnings-per-share of $3.67 (26% increase)
- 2009 earnings-per-share of $3.98 (8% increase)
- 2010 earnings-per-share of $4.60 (16% increase)
McDonald’s grew earnings in each year of the recession, at a double-digit compound annual rate. This is highly impressive, and speaks to its recession-resistant business model.
Investors can be reasonably assured the company can continue raising the dividend, even if another recession hits.
Valuation & Expected Returns
McDonald’s stock has generated huge returns in recent years. The stock has almost doubled since the beginning of 2015. Using the current share price of ~183 and expected earnings-per-share for 2018 of $7.60, the stock has a price-to-earnings ratio of 24.1. This is above the stock’s five-year average price-to-earnings ratio of 20.
If shares were to revert to their average valuation, annual returns would be reduced by 3.7% through 2023.
Therefore, McDonald’s appears to be slightly overvalued, based on relative comparisons to the broader market, as well as to its own historical average. The following table shows McDonald’s average price-to-earnings ratio over the past 10 years.
Investors cannot rely on continued expansion of the price-to-earnings ratio to drive returns. Going forward, returns will be generated from earnings growth and dividends.
In the past 10 years, McDonald’s grew earnings-per-share by 5.9% compounded annually. With its turnaround well underway, this could be a reasonable baseline of expectations going forward.
A potential breakdown of future returns is below:
- 5.9% earnings growth
- 3.7% multiple reversion
- 2.5% dividend yield
From this, total returns would reach approximately 4.7% per year through 2023. The relatively low expected return is due entirely to McDonald’s stock valuation, which is high at the present time.
McDonald’s has paid a dividend for over 40 years in a row. Over those four decades, it has had to reinvent itself from time to time, to stay on top of changing consumer trends.
It recently had to do this once again, but the results have been very encouraging. Same-store-sales and earnings are growing, which is powering McDonald’s dividend growth.
That being said, investors aren’t likely to see sizable gains with the high valuation of the stock. Investors should wait for a pullback before adding McDonald’s.