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Summary

  • Long history of growing cash dividends.
  • Opportunity for global expansion will allow the cash flows to grow.
  • Current payout ratio of about 72% gives room for further growth in dividends.

McDonald's (NYSE:MCD) is one of the highest-yielding stocks in the sector, and its current dividend yield is close to 3.4%. The company has a long history of growing its quarterly dividend, and its annual dividend increase comes after the third quarter of the year. At the moment, the stock pays an annual dividend of $3.24, up from $3.04 for the last year. Due to the solid dividend yield, the stock has attracted a large number of investors over the last few years, which has resulted in a five-year capital gain of over 80% -- however, more recently, the stock has been trending downwards, and it has lost about 3.25% during the last twelve months. In this article, however, we will be mainly focusing on the dividends, cash flows and the prospect of future growth in dividends.

Dividends, Cash Flows and Future Growth in Dividends

The company has raised its dividend every year since its first dividend. For more than half a decade (2000-2007), the company chose to pay dividends annually, before reverting back to quarterly dividends in 2008. During the last year, McDonald's paid cash dividends of $3.1 billion, up by almost 8% compared to the previous year. This incremental dividend is due to the improved allocation of resources over the period, with better revenue and operational outcome. Furthermore, the company also distributed about $1.8 billion through share repurchases during the last year. Therefore, the company has returned a total of around $4.9 billion to shareholders through dividends and share buybacks.

Moving on to the payout ratio - my preferred method is payout ratio based on the free cash flows. McDonald's reported total free cash flows of $4.29 billion over the last year, which puts the payout ratio of the company at around 72.5%. The payout ratio based on free cash flows is a little high for my liking - however, there is still a healthy buffer available to the company. About 27.5% of its free cash flows are still available to McDonald's to grow its dividends in the future. A look at the revenues and earnings shows that the growth in the earnings has been slow but stable for the company, which is a clear sign that the company is operating in a mature industry.

As a result, the company has decreased its capital expenditures by 7.34%, further enhancing the free cash flows. We are likely to see the same pattern in the future, as the company will only be spending on maintaining its current position in the market. Therefore, despite the slow growth rate in revenues and earnings, the cash flows of the company will have room to grow dividends further.

Future Growth

McDonald's is looking for further global expansion by opening 1,500-1,600 new restaurants and re-imaging about 1,000 of its existing locations. At the moment, the global Informal Eating Out [IEO] segment of the market is growing at a good pace. McDonald's discussed the Informal Eating Out market in its 10-K, where the company used a study by Euromonitor International. According to the findings of the study, the global Informal Eating Out segment generated sales of approximately $1.2 trillion, of which McDonald's represented about 8% of the sales. The company is trying to improve this proportion by putting a larger chunk of resources towards opening new restaurants in the current year.

Overall, McDonald's has a good opportunity to expand its sales in the global markets, which will cover the shortfall in the domestic sales. Following this path, the company has recently announced the official opening of its first restaurant in Vietnam, which marked the 10,000th restaurant for the chain in the Asia, Pacific, Middle East and Africa region. The company can enhance its sales by tapping these previously untapped markets.

Conclusion

I do not believe there will be a major rise in the stock price in the short term. I believe the stock price will remain around the current levels, as the growth in the business has become somewhat stagnant. However, the stock still remains a healthy income option. I do not expect a dividend cut, and the company has enough of a buffer in its cash flows to continue growing its dividends. Furthermore, the global expansion will allow the company to further enhance its cash flows in the medium-long term.

Source: McDonald's: A Good Addition To The Dividend Portfolio?