McDonald's Corp (MCD)

09 Aug 2013 19:52

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McDonald's (symbol MCD) has long been a staple in many Dividend Growth Investor (DGI) portfolios. When you look at its historical dividend growth MCD rewarded shareholders extremely well over the years. The fact that they have increased dividends for 36 straight years it is no surprise as to why it is a dividend favorite among investors.

Dividend Growth Rates
1-Yr 3-Yr 5-Yr 10-Yr
13.4% 11.9% 13.9% 28.4%

A more detailed look at some numbers and ratios MCD meets many of the criteria I look for in a Dividend Growth stock:

Dividend Growth Rate Debt/Equity Ratio
Criteria MCD Criteria MCD
>= 7.2% 13.4% < 1 .84
Dividend Yield Payout Ratio
Criteria MCD Criteria MCD
> 3% 3.1% < 70% 56%

The main competitors are Burger King (BKW) and Wendys (WEN). Looking at BKW & WEN they currently have P/E Ratios of 45.98 and 214 versus 17.87 for MCD making it look like the value of the three. But the average P/E for MCD over the last five years has been 16.5 so it is slightly over-valued at its current price of $97.90 per share.

An area of concern has been the surge of small specialty hamburger chains such as Five Guys Burger, In-N-Out Burgers, and Jake’s Wayback. But I see this more of a problem with WEN and to some extent BKW. What is insulating MCD from the specialty burger onslaught is its virtual size. MCD currently has 34,480 restaurants in over 118 countries and when we compare to BKW with 12,997 and WEN with 6,560 restaurants it is easy to see how massive of a scale MCD’s operations are in comparison.

Additionally, 58% of MCDs restaurant are in foreign countries where they do not have to compete with the recent U.S. surge of specialty burger joints. Growth has primarily been in the Asia-Pacific area where it has increased 6.6% from 2011 to 2012 going from 8,865 to 9,454 restaurants and is seven times more penetrated than its closest competitor (BKW has 1,010 restaurants in Asia). Of course as the U.S. dollar strengthens this can turn into a weakness due to currency exchanges.

On the earnings front, earnings per share growth slowed to 5% in 2012 and estimates for 2013 range from 4-5% growth. A fear going forward is if the 13.4% dividend growth rate is sustainable. With a payout ratio of only 56% and combining it with a 4-5% EPS growth rate, dividend growth should continue at a decent pace (7-10% annually) for the next 7 years before it hits my limit of a 70% payout. Personally I do not see MCD management being content with such a slow growth rate over an extended period of time. Their focus on keeping a modern fresh menu and increasing franchise fees should increase growth rates as early as 2014.

Overall, though slightly overvalued, I would not hesitate initiating a small position of MCD in my portfolio and if the stock price drops back to its average P/E of 16.5 (approximately $90 per share) I would increase my investment amount.

Note: I do not own this stock at time of this writing but do have a buy interest.

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