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Introduction

I was a frequent traveler to Russia in 1990 when McDonald's (NYSE:MCD) opened its first store in Moscow. Ironically, the apartment where I was residing overlooked the Golden Arches and the colorful, new and shiny store (equivalent to 3-4 of the standard MCD stores) was a shining light on the otherwise dull and dreary Russian landscape.

For me, as an American, this first Russian McDonald's was a daily source of wonderment. The operation was so successful and the lines were so long (many city blocks long) that it spawned a new business for young Russian entrepreneurs which was "line waiting." The closer a line waiter was to the front door, the more you paid to have your order processed!

This Russian hunger for big Macs and fries was astounding to watch, but even more astounding was their appreciation of what Ray Kroc had preached since founding MCD in 1955: "Quality, Service, Cleanliness and Value."

By adhering to these simple but critical values, MCD has prospered. Its current stock price will look very cheap 5 or 10 years from now. I believe that the MCD values espoused over the years, along with its operating philosophy matter a great deal, and they'll continue to enhance the strength and profitability of its iconic brand.

Overview

Today, there are some 34,000 McDonald's operating in 120 countries that serve around 68,000,000 people per day. Of the total MCD locations, approximately 85% of them are franchised.

With more than a billion shares outstanding and a beta of only .34, the stock doesn't wander around very much. In terms of dividends, MCD is legendary for its shareholder friendliness. Currently, it is paying out 54% of net income to its shareholders (compared with around 30% of the average S&P company), which has resulted in increased shareholder dividends for 25 consecutive years, making it one of the S&P 500 Dividend Aristocrats.

In the 1990s MCD set a course of diversification by developing and acquiring other brands such as its majority stake in Chipotle Mexican Grill , Donatos Pizza and Boston Market. A decade later, it returned to focusing on its core brand by divesting itself of these brands, and did so at enormous profits.

How a Philosophy Can Create Profits

As we know, the unique business model upon which Ray Kroc chose to build his empire and realize his goals was to persuade others (both franchisees and suppliers) to become part of the MCD family. His slogan, "In business for yourself, but not by yourself " epitomized his vision and philosophy. Now, nearly 60 years later, it's used by franchisors throughout the world to attract prospective franchisees and express their copy-cat philosophy of success.

In retrospect, the simple, but dynamic Kroc model was brilliant and has, to a large degree, accounted for the company's global success. It's a great example of how a steadfast philosophy can translate to extraordinary growth and profits. His franchise concept and his ability to delineate it so clearly to MCD operators created results. For example, while Kroc and the company were great innovators, some of MCD's most successful product innovations such as the Big Mac, Filet-O-Fish and the iconic Egg McMuffin were developed by franchisees.

Kroc's insistence on "Quality" was not just simply suggestive, but it was passionate and evolved into a scientific method whereby every ingredient was tested, tasted and perfected to make certain they were the very best and would fit into the MCD operating system and would be embraced by consumers. Ultimately, the whole concept of "Quality" and consistency was manifest in the founding of the MCD "Hamburger University."

How MCD Makes Money - Dissecting the MCD Franchise Agreement

While investors generally focus on the metrics and the bottom line, I believe it's also imperative to understand where the numbers come from and how they're developed. As will be seen from the bullet points below, the MCD structure is slightly different from that of most other fast-food chains. MCD is very much in the real estate business as it is in flipping burgers (which is an asset building boon for shareholders):

  • MCD earns money as an investor in properties. Virtually ALL of its franchised locations are owned by MCD, and pursuant to an "Operator's Lease," franchisees pay rent to MCD.
  • In addition, franchisees pay various ongoing fees to MCD including a 4% Royalty on Sales. (So, when you spend $10.00 at a McDonalds, you've contributed $.40 to MCD's treasury.)
  • MCD's massive advertising campaigns are paid for by the ongoing "Marketing & Advertising" Fees paid by franchisees pursuant to the Franchise Agreement
  • MCD does not provide any financing to franchisees
  • There are no exclusive "Protected Territories" in the Franchise Agreement, and the Franchise Grant only covers the specific location of a Franchisee

When one considers all of the above, it's understandable why MCD assets have grown over the years along with its dynamic cash flow and profits. Its model is inherently conservative, which is great for value and dividend investors.

The Only Question is "When" to Add MCD to One's Portfolio

The stock closed on Friday, 2/15/2013 at $93.90 after having backed off from a recent high of $96.00. If you're a believer that the market will make a correction in the near future, MCD appears to have short-term support in the $85.00 to $86.00 range, and at that level its effective yield would be 3.58%.

In any event, its $3.08 annual dividend will provide a "floor" for the stock price.

Following is a summary of MCD'S's significant metrics:




MetricFactor/Number
Closing Price 2/15/2013$93.90
PE Ratio17.52
2012 Dividend Per Share$3.08
Next Ex-Dividend Date02/27/13
Effective Yield3.08%
52 Week High$101.04
52 Week Low$83.31
Beta0.34
5 Year Growth Rate12.36%
Current Year Est. EPS$5.79
Next Year Est. EPS$6.35
Compiled by Craig Van Pelt
SOURCE: Scottrade

MCD 2012 Full-Year Financial Highlights

  • Global comparable sales increased 3.1% (U.S. + 3.3%, Europe +2.4% and APMEA + 1.4%)
  • Consolidated revenues + 2% (5% in constant currencies)
  • Consolidated operating income + 1% (4% in constant currencies)
  • Diluted earnings per share of $5.36 up 2% (5% in constant currencies)
  • $5.5 billion returned to shareholders through dividends and share repurchases

MCD Dividends and Splits

Forward Annual Dividend Rate3.08%
Forward Annual Dividend Yield3.30%
Trailing Annual Dividend Yield2.87%
Trailing Annual Dividend Yield3.10%
5 Year Average Dividend Yield3.20%
Payout Ratio54.00%
Dividend Date03/14/13
Ex-Dividend Date02/27/13
Last Split FactorTwo for One
Last Split Date03/08/99

Conclusion

There are a host of superlatives that can be used when speaking about McDonald's. Using any metric, MCD is rock solid. For decades, it's beaten the competition and will likely remain the undisputed global leader in its sector. It's perfect for any and all portfolios, and it's especially attractive right now in our era of low interest rates. Adding MCD to one's portfolio is, in my view, a must. Buy it today since it will likely cost a lot more in the future.

Disclosure: I am long MCD. 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.

Source: McDonald's: Today's Price Will Look Cheap 5 Years From Now