- McDonald's has a $100 billion market cap and a 3.2% dividend yield.
- The author looks at McDonald's impressive real estate operations.
- The dividend is likely safe for 2014 and 2015. Dividends have grown every year since 1976.
McDonald's (NYSE:MCD) has an incredible history of dividend growth since 1976. I attribute much of this success to the empowered entrepreneurs who understand market conditions and can make changes much faster than a typical company with a market cap of over $100 billion.
This article should be the first in a series that I write about this dividend growth company. Earlier in the week, I wrote about pensions at large multinational companies. McDonald's does not have defined benefit pension plans of the size and scope of older blue-chip companies. Those would include the likes of AT&T (NYSE:T) or General Electric (NYSE:GE).
I believe it makes sense to analyze MCD as a real estate company which happens to serve burgers and fries. The business model is collecting royalties and rent from franchisees.
The Triple Net Lease Arrangement with Franchisees
Conventional franchise arrangements generally include a lease and a license and provide for payment of initial fees, as well as continuing rent and royalties to McDonald's based upon a percent of sales with minimum rent payments. Under this arrangement, franchisees are granted the right to operate a restaurant using the McDonald's System and the use of a restaurant facility for 20 years. These franchisees pay related occupancy costs, including property taxes, insurance and maintenance. For those interested in commercial real estate, this is much like a triple net lease (sometimes called NNN).
Revenues from franchised restaurants consisted of:
Royalties and initial fees
Revenues from Franchised Restaurants
McDonald's owns and leases real estate primarily in connection with its restaurant business. It identifies and develops sites that offer convenience to customers and long-term sales and profit potential. To assess potential, MCD analyzes traffic, walking patterns, and census data. The company's experience and access to advanced technology aid in evaluating this information. The company generally owns the land and building or secures long-term leases for restaurant sites, which ensures long-term occupancy rights and helps control related costs.
Restaurant profitability for both the company and franchisees is important; therefore, ongoing efforts are made to control average development costs through construction and design efficiencies, standardization and by leveraging the company's global sourcing network.
Of the 35,429 restaurants at FYE 2013, 28,691 were franchised and 6,738 were operated by the company.
Under the conventional franchise arrangement, franchisees provide a portion of the capital required by initially investing in the equipment, signs, seating and décor of their restaurant business. The company owns the land and building or secures long-term leases for both company-operated and conventional franchised restaurant sites.
At FYE 2013, MCD was the lessee at 14,815 restaurant locations through ground leases (the company leases the land and the company or franchisee owns the building) and through improved leases (the company leases land and buildings). Lease terms for most restaurants are for 20 years, and provide for rent escalations and renewal options. Escalation terms vary, but might include fixed-rent escalations or escalations based on an inflation index. For most locations, the company is obligated for the related occupancy costs including property taxes, insurance and maintenance; however, for franchised sites, the company requires the franchisees to pay these costs.
In 2013, cash from operations was $7.1 billion. This was the second strongest year ever from a cash flow standpoint (2011 was slightly higher). Capital expenditures of approximately $2.8 billion were invested in the business, and more than half was devoted to new restaurants. During 2013, 1,438 restaurants were opened and over 1,500 existing locations were re-imaged.
I conclude that the MCD dividend is safe for 2014 and into 2015. MCD trades roughly in-line with the S&P 500. The trailing P/E ratio is about 18x for both MCD and the S&P 500. Also, note that MCD has an above market dividend yield of 3.2% compared to an S&P 500 dividend yield of 1.7%. Regardless of whether the reader agrees that this is a real estate and franchising company, which happens to deal in hamburgers, I rate this stock a Buy.
This article did not completely analyze the many risk factors that the company faces, including rising commodity costs and the complexity of dealing in over 100 countries. The company also earns revenue in many currencies, including the pound sterling, euro, Canadian dollar and Russian ruble.