Dividend Aristocrats In Focus: McDonald’s Corporation - Sure Dividend

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Dividend Aristocrats In Focus: McDonald’s Corporation


Updated on February 11th, 2021 by Bob Ciura

Every year, we review each of the 65 Dividend Aristocrats, the group of companies in the S&P 500 Index, with 25+ consecutive years of dividend increases. We believe the Dividend Aristocrats are among the best stocks to buy and hold for the long run.

Broadly speaking, to make it on the list of Dividend Aristocrats, a company must possess a profitable business model with a valuable brand, global competitive advantages, and the ability to withstand recessions. This is why the Dividend Aristocrats can continue to raise their dividends in difficult years, such as the 2020 coronavirus pandemic.

With this in mind, we have created a list of all 65 Dividend Aristocrats. You can download your free copy of the Dividend Aristocrats list, along with important financial metrics such as price-to-earnings ratios and dividend yields, by clicking on the link below:

 

McDonald’s Corporation (MCD) embodies all of the qualities inherent in a Dividend Aristocrat. 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.

McDonald’s has implemented a successful turnaround in recent years, through new menu offerings, remodeled restaurants, and an accelerated investment in technology. Put together, these initiatives should help McDonald’s continue to raise its dividend for many years, although the stock appears to be overvalued today.

Business Overview

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. Today, McDonald’s operates approximately 39,000 locations, in more than 100 countries around the world.

Revenues come primarily from franchise fees. McDonald’s has accelerated its franchising over the past several years. While this effort initially led to lower sales, it allowed McDonald’s to expand its profitability through higher margins. And with the franchising efforts lapped, McDonald’s is back to reporting impressive sales growth in addition to earnings growth.

On January 28th, 2021 McDonald’s reported fourth-quarter and full year 2020 results. For the fourth quarter, total revenue came in at $5.31 billion, representing a -2.1% decline compared to Q4 2019. Revenue at company-owned restaurants was down -5.5%, while revenue from franchised restaurants –which has notably higher margins –was flat. On an adjusted basis earnings-per-share equaled $1.70 for the fourth quarter, compared to $1.97 in the year-ago quarter.

For the year, McDonald’s generated revenue of $19.21 billion, a -10.0% decline compared to 2019, as the company felt the effects of the COVID-19 pandemic. Company-owned restaurant revenue was down -13.6%, while revenue from franchised restaurants was down -8.0%. Reported net income equaled $4.73 billion or $6.31 per share compared to $6.03 billion or $7.88 per share in 2019.On an adjusted basis, earnings-per-share equaled $6.05 versus $7.84 in 2019.

While 2020 was a difficult year for McDonald’s, the global economy should recover from the coronavirus pandemic in 2021. For this reason, we expect McDonald’s to return to growth this year, and beyond.

Growth Prospects

McDonald’s performance has improved in the past few years, 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 sees the potential to grow its unit count in the years couple of years.

Source: Investor Presentation

McDonald’s has plenty of additional catalysts for growth. McDonald’s announced new menu offerings, including all-day breakfast which provided a big boost to sales. A renewed focus on providing value to customers has also helped restore traffic. McDonald’s has also embraced technology in recent years, by utilizing new technologies that help get food to customers faster.

For example, it has partnered with third-party delivery services such as Uber (UBER) Eats and GrubHub (GRUB), while it also recently acquired voice technology firm Apprente. Apprente makes artificial intelligence technology which can provide faster and more accurate fulfillment of drive-through orders. McDonald’s has also rolled out mobile ordering as well as kiosks at many of its restaurants to simplify the ordering process even further.

This has helped McDonald’s post strong results in the United States. In 2020, comparable sales in the U.S. increased 0.4%, which helped offset negative comparable sales of -15% in the International Operated segment and -10.5% in the International Developmental Licensed segment.

We expect McDonald’s to generate 6% annual earnings-per-share growth over the next five years. This growth will be comprised of sales growth, and share repurchases.

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 one of the most valuable and widely-recognized brands in the world.

One of the big reasons why McDonald’s continues to increase its dividend each year, 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.

Related: The Best Fast Food Stock Now: Ranking The 6 Biggest U.S. Fast Food Stocks

From this perspective, McDonald’s actually benefits from recessions. For evidence of this, its earnings-per-share during the Great Recession are shown below:

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. For example, in the past five years McDonald’s stock generated total annualized returns of 15.7% per year. The only downside from this outstanding performance is that the stock now appears to be overvalued. Using the current share price of ~$214 and expected earnings-per-share for 2020 of $8.40, the stock has a price-to-earnings ratio of 25.5.

Over the past decade, shares of McDonald’s have held an average P/E ratio of 21. We consider 19 times earnings as a reasonable fair value estimate. If shares were to revert to a P/E valuation of 19, annual returns would be reduced by 5.7% through 2026.

Therefore, McDonald’s appears to be overvalued, based on relative comparisons to the broader market, as well as to its own historical average. Fortunately, the impact of overvaluation will be offset by earnings-per-share growth and dividends. In addition to expected EPS growth of 6% per year through 2026, the stock also offers a current dividend yield of 2.4%.

Overall, McDonald’s is expected to generate total returns of just 2.7% per year, a weak projected rate of return. The relatively low expected return is due to McDonald’s stock valuation, which is abnormally high at the present time.

Final Thoughts

McDonald’s has paid a rising dividend for 45 years in a row. Over those four-and-a-half decades, it has had to reinvent itself from time to time, to stay on top of changing trends in the restaurant industry. But it has consistently succeeded in its various turnarounds, a testament to the strength of its brand and business model.

It recently had to do this once again, but the results have been very encouraging. Last year was a highly challenging one, and McDonald’s was significantly impacted by the weak global economy. But a return to growth is likely for this industry leader in 2021.

That said, investors aren’t likely to see sizable gains with the high valuation of the stock. As a result, we believe investors should avoid the stock and wait for a pullback before buying McDonald’s.

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