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Summary

  • McDonald's has a market cap of $100 billion and a dividend yield of 3.2%.
  • The company showed a dividend coverage ratio of 1.6x in Q1 2014.
  • The flexibility of the business model and a presence in 120 countries offers a unique investment opportunity, much like the Dead were cut from a different cloth.

The scope of this article will look at the financial health of McDonald's (NYSE:MCD), and the ability to continue to pay the dividend. While investors see the current yield of 3.2% as very attractive, the powerful business model and the ability to raise the dividend mandates that investors looking for growth give this stock another look.

How Safe is the Dividend?

Cash flow summary ($ in millions)

Quarter Ended 3/31/14

FYE 12/31/13

FYE 12/31/12

Cash from operations

$1.9

$7.1

$7.0

Capex

($0.6)

($2.8)

($3.0)

Borrowings / (Repayments)

($0.2)

$0.5

$1.2

Dividends

($0.8)

($3.1)

($2.9)

Repurchases of common stock

($0.4)

($1.8)

($2.6)

Dividend coverage ratio*

1.6x

1.6x

1.4x

In the above chart, negative numbers are a usage of cash, while positive numbers are a source of cash.

The cash balance at 3/31/14 was $2.7 billion.

* I define the Dividend Coverage Ratio as Cash from Operations less capex divided by the dividend. For example, in the first quarter, this was (1.9 minus 0.6)/(0.8), or 1.6x. I don't feel like the dividend increases in 2014 or 2015 will be over 5%, as these dividend coverage ratios are not robust enough for the 20%+ increases that dividend growth investors look for.

For more comparisons on other large cap dividend coverage ratios, see this article on AT&T (NYSE:T) or this article on Disney (NYSE:DIS). Please note that Starbucks (NASDAQ:SBUX) had a dividend coverage ratio of 3.3x for the most recent six months of operations, and I concluded that this dividend would be raised in the next couple months.

2014 and 2015 Outlook

McDonald's expects capital expenditures for 2014 to be between $2.9-$3.0 billion. Over half of this amount will be used to open new restaurants. The Company expects to open about 1,500-1,600 restaurants including about 500 restaurants in affiliated and developmental licensee markets, such as Japan and Latin America, where MCD does not fund any capital expenditures. MCD expects net additions of between 1,000-1,100 restaurants. The remaining capital will be used to reinvest in existing locations, in part through reimaging. Over 1,000 restaurants worldwide are expected to be reimaged, including locations in affiliated and developmental licensee markets that require no capital investment from MCD.

McDonald's expects to return approximately $5 billion to shareholders through dividends and share repurchases in 2014.

Given the above outlook, I surmise that MCD will serve up another 5% dividend increase in September of 2014.

A Vignette About the Grateful Dead

For many years, the Grateful Dead was one of the most popular and highest grossing bands in the United States. This is not bad for a band whose lead guitarist was missing two-thirds of his middle finger. Two quotes about the Dead illustrate what is important about McDonald's competitive advantages.

Jerry Garcia made the observation that "our audience is like people who like licorice. Not everybody likes licorice, but people who like licorice really like licorice." Garcia understood that the band wouldn't appeal to everyone, but the fans they did have were incredibly passionate. When I go to a McDonald's in the morning, I can see numerous customers purchasing an Egg McMuffin in the drive thru or a group of elderly drinking coffee less expensive than Starbucks, while discussing the state of the world.

Bill Graham, a rock concert promoter, once commented, "The Grateful Dead aren't the best at what they do; they are the only ones that do what they do." The band has a distinct sound, a distinct approach to selling tickets, a distinct music video and simply a different ethos.

Similarly, McDonald's remains a modern marvel. It's the biggest restaurant chain in the world, measured by sales, serving 69 million people a day, with 14,157 restaurants in the U.S. and more than 35,000 worldwide in 120 countries. More Americans visit McDonald's than any other chain of any kind, including Walmart (NYSE:WMT).

In another article from last month, I argued that McDonald's was essentially a real estate company. I received negative feedback from that article because what real estate company offers hamburgers and cheeseburgers, Big Macs, Quarter Pounders with Cheese, the Filet-O-Fish, Chicken McNuggets, wraps, french fries, salads, oatmeal, shakes, McFlurry desserts, sundaes, soft serve cones, pies, soft drinks, coffee and McCafé beverages? Yes, MCD is unique.

McDonald's views itself primarily as a franchisor which delivers locally-relevant customer experiences and strong profitability. However, directly operating restaurants is paramount to being a credible franchisor and is essential to providing personnel with restaurant operations experience. The company continually reviews and adjusts the mix of Company-operated and franchised restaurants to help optimize overall performance.

Conclusion

I conclude that the MCD dividend is safe for 2014 and into 2015, primarily due to the dividend coverage ratio and the continued ability to adapt menus to moderate inflation across the planet.

The above article is an opinion, and not investment counsel.

Source: McDonald's: The Dividend And The Grateful Dead