Dividend Aristocrat in Focus: McDonald’s (MCD)

The Dividend Aristocrats are a select group of currently 57 S&P 500 stocks with 25+ years of consecutive dividend increases. These 57 are large, US companies that have historically provided (slightly) better performance and (slightly) lower volatility than the S&P 500 as a whole.

S&P 500 applies the following criteria to construct the Dividend Aristocrats list:

• must be members of the S&P 500
• must have increased dividends every year for at least 25 consecutive years
• Market Cap at least USD 3 billion
• Liquidity at least USD 5 million (average daily value traded)
• Diversification, at least 40 constituents and not sector allocation above 30%

Read more about the dividend aristocrats’ performance or check-out the European dividend aristocrats.

There are currently 66 Dividend Aristocrats. You can download an Excel spreadsheet of all 66 (with metrics) for FREE by joining our newsletter:

 

This “in focus article” will discuss several aspects of the dividend aristocrat McDonald’s (MCD) and why the stock could be attractive for income investors based on our Dividend Score. Our Dividend Score System takes into account several fundamental and technical metrics that affect a company’s ability to continue paying dividends and its overall return.

 

McDonald’s (MCD) overview

 

	Dividend Score
	70
Dividend	Dividend Yield	DGR 3 years
4.64	2.39%	6.80%

Data: December 8th, 2019

Business model and growth perspective

McDonald’s Corporation operates and franchises McDonald’s restaurants in the United States and internationally. Its restaurants offer various food products, soft drinks, coffee, and other beverages, as well as a breakfast menu. The company operated almost 38,000 restaurants, including 35,000 franchised restaurants. McDonald’s Corporation was founded in 1940 and is based in Chicago, Illinois. McDonald’s is a market leader and a wide economic moat, a high-quality business and well-positioned in its market.

McDonald’s has an impressive track record of delivering strong growth for decades, both in the U.S. and overseas.  McDonald’s ownership of real estate, combined with the co-investment by franchisees, enables the company to achieve growth levels that are among the highest in the industry.

McDonald’s earnings grew by 12.7% over the past year and analysts are forecasting an earnings growth of 5.42% per year. Overall, we expect McDonald’s to generate 6% annual earnings-per-share growth over the next five years.

Dividend history and dividend growth

It is important that companies that can maintain or even increase their dividend payments in bad times. This is an indication that the company has a strong market position in a stable business that performs well throughout the economic cycle.

McDonald’s recently increased its quarterly dividend to $1.25/share, which is a 7.8% increase from prior dividend of $1.16. The 8% dividend boost follows last year’s 15% hike ($1.01/share). This is also McDonald’s 43rd straight year of consecutive annual payout raises, stretching back to the year 1976.

The 3-years dividend growth is 6.8% per year, which is “average”.

 

Dividend Yield

McDonald’s Corp. current dividend yield of 2.38% is -15% below its 5-year average. The 5-year average dividend yield is 2.79% (see red-line in the chart). This indicates the stock looks overvalued today.

The dividend payments are reasonably covered by its earnings, given the payout ratio of 59%. Looking forward, its dividends in 3 years are forecast to be well covered by earnings (61% payout ratio). This future payout ratio is edging towards the high side for this sector, we prefer a payout ratio around 50%.

Stable cash flow

Without stable cash flow, it is almost impossible to maintain the dividend in times of a downturn. Operating free cash flow and free cash flow are 2 important metrics for a dividend stock. MCD has generated positive free cash flow in each of the last 10 years, which is a sign that MCD’s business has consistently earned enough cash to cover its spending needs, giving MCD more flexibility to maintain its dividend over time.

Low debt ratio

Companies with a low debt ratio have the option of maintaining or even increasing the dividend even during recessions. The (net) debt-to-EBITDA ratio is a great metric to include. The net debt/EBITDA of 3.03 is indicating that MCD’s ratio is high. This is way above the 1.5 net debt/EBITDA ratio we prefer for dividend stocks.

Valuation

MCD’s forward P/E ratio of 23.6 is about in line with its 5-year average of 21.6. Furthermore, MCD’s forward P/E ratio is well above the Consumer Discretionary sector average of 15.9. Therefore, McDonald’s appears to be slightly overvalued, based on relative comparisons to the broader market, as well as to its own historical average.

Recession performance

It is important to analyze the performance of a dividend stock during a recession period.  We analyze each dividend stock by looking at their earnings, dividends, maximum drawdown (MDD) and stock price performance during the 2007-2009 financial crisis.

MCDs earnings-per-share performance during the Recession period (2007-2009) can be seen below:

• 2007 adjusted earnings-per-share of $2.91
• 2008 adjusted earnings-per-share of $3.67 (26% increase)
• 2009 adjusted earnings-per-share of $3.98 (8% increase)
• 2010 adjusted earnings-per-share of $4.60 (16% increase)

The share price of McDonald’s Corporation increased during the 2007-2009 financial crisis. It was one of the few stocks that did not experience a large decline from 2007 to 2009, the MDD was around 35%.  See the stock price chart below:

Price-performance

Year-to-date McDonald’s is trading up 11%, which is an underperformance çompared to the S&P 500. The 10-year geometric annual performance is 10.9% annually. Looking at the win-ratio of 78.5% and a loss ratio of 1.8, those two ratios are strong and certainly above average for this stock. Look at the performance triangle, especially investors who started investing in MCD end of 2011 had a difficult start.

MCD’s performance triangle.

 

Final Thoughts

McDonald’s valuable real estate portfolio, predictable stream of high-margin rent payments and royalty fees from its franchisees, the stock represents a fundamentally lower-risk dividend growth investment. Overall, we expect McDonald’s to generate 6% annual earnings-per-share growth over the next five years and continue to grow its dividend as well.

Since the stock is on overvalued based on current PE-ratio’s and dividend yield, our recommendation for long-term dividend growth investors would be “Buy the Dips”.