McDonald's Shareholders: We Got A Few More Years Of Low Growth Ahead

| About: McDonald's Corporation (MCD)


Price increases at McDonald's are making it difficult for the company to grow foot traffic.

The company is continuing to buy back stock, which boosts earnings per share by about 1.75% per year.

Most of the company's growth is coming from new store openings, which should add 4%-5% earnings growth in the near term.

For most of the 2000s and early part of the 2010s, McDonald's (NYSE:MCD) offered investors everything they could possibly want: stock price appreciation, earnings growth, and dividend growth. Over the past ten years, the price of the stock has climbed from $24.50 to $95.50, the earnings per share figure increased 14.0% annually, and the dividend grew by an eye-popping 27.0% annual rate between 2004 and the start of 2014.

In the fourth quarter, McDonald's increased its dividend from $0.77 to $0.81, giving investors 5.19% growth that is much lower than what they had come to expect during the preceding ten years. This slower dividend growth was matched by lower earnings figures, as McDonald's only managed to grow its profits from $5.36 to $5.55 over the same time period, for a growth rate of only 3.54%.

Worst of all, this low growth wasn't due to a rise in profits, but rather, share buybacks. McDonald's only increased its actual profits $5.4 billion to $5.5 billion (for organic growth of 1.85%), but was able to stimulate earnings per share growth by reducing the share count from a little over 1.0 billion to 977 million. In other words, earnings are growing at 3.5%, and half of that is due to actual business growth, and the other half is due to share repurchases.

When you think broadly about McDonald's, the company currently has two problems: it's having trouble increasing foot traffic at its restaurants, and it's having trouble trying to increase profits in Europe. Globally, the traffic declined 0.2% at restaurants that have been in existence for more than a year, and even when you adjust for the new store openings, the company still only managed to increase sales 1.9% to $7.1 billion.

The company is going to have a hard time increasing foot traffic, because it is currently increasing prices. The advertising campaign "Dollar Menu & More" hasn't been persuasive with food customers, because all they see are higher prices for the same food items. Historically, the company increases foot traffic when it lowers prices, and it's going to be unlikely for McDonald's to increase sales at a rate higher than its anemic 1.9% figure, because the core customer base is sensitive to price increases.

Europe (especially Germany) is currently a sore spot for the company, as profits have fallen 1.8% over the past year (the business is technically doing worse in the Middle East & Africa, where profits have fallen 2.5%, but those areas don't influence the company's net profits nearly as much as European countries). Given that sales aren't growing in Europe, and McDonald's has plans to bring price increases there as well, it is going to be worth watching whether the price increases at European locations will be enough to offset any foot traffic lost in response to those price increases. If history and common sense are any guide, it will take a couple of years of growing pains before McDonald's can charge higher prices and start to see increases in the foot traffic figures.

The question, then, is this: What is McDonald's going to do to grow profits for shareholders in the near term, as any dividend increases will have to be the result of commensurate profit growth, because McDonald's doesn't really have the room to increase its payout ratio above the current 61% level.

Well, the company is going to be opening 1,600 new stores this year, which will increase the total count to 37,029 across the world. In other words, the store count should increase by 4.51%, and if those stores perform in line with the profitability of the average McDonald's franchise, then we should be looking at about 4%-5% earnings per share growth as well. Additionally, the company is remodeling almost 1,000 stores in a bid to increase foot traffic, and that is an ongoing project that will be taking place over the next couple of years.

The company will also be continuing its buyback program, and it'll probably retire about 17 million shares this year. Considering that the company currently has 977 million shares outstanding, we're going to see about 1.75% earnings per share growth that result from stock buybacks over the coming year.

Here's my three-year prediction for profits at McDonald's: the days of double-digit earnings growth and dividend growth that we saw during the 2000s are going to cool off for a bit. McDonald's has not been increasing profits meaningfully at its existing franchises, and higher prices are probably going to be offset by lower foot traffic in the near term. The growth, then, is going to come from 4%-5% growth that is the result of McDonald's opening new stores, and you are going to get another 1.75% from the buyback. In other words, the 10% growth that we've gotten used to is going to become 6% or so growth over the next couple years. Given that the company's P/E ratio is in line with historical averages, and given that its dividend payout ratio doesn't have much room to grow at 60%, I'd expect capital appreciation and dividend growth to be around that 6% range as well over the next couple of years.

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.