- McDonald's is under competitive pressure, but fast food isn't going away any time soon.
- Management plans to return $18 billion-$20 billion to investors through 2016.
- Assuming a steady multiple, dividend growth and share buybacks mean 10% annual returns aren't out of the question.
McDonald's (NYSE:MCD) is stuck in a difficult time, to put it mildly. Its core low-income consumer is still strapped for cash, and preferences among higher-end consumers are increasingly shifting toward healthier quick-service options like Chipotle Mexican Grill (NYSE:CMG).
Indeed, McDonald's last quarterly report was an ugly one. Sales growth at locations open at least one year is non-existent in the United States. Because of this, McDonald's came well off its highs of the year, around $104 per share which it reached prior to its earnings results, to rest at its current level of $93 per share.
But it's a mistake to think McDonald's is an outright sell. Underneath the scary headlines is a reasonably-valued stock with a strong balance sheet and compelling dividend.
Growth plan intact
It's easy to get swept up in the pervasive panic over what the future holds for McDonald's. Indeed, consumers are slowly but surely adopting healthier eating habits in the United States, and many are opting for food with fresher, better-sourced ingredients at places like Chipotle.
This is having an effect on McDonald's, which produced flat comparable sales growth last quarter, and just 1% growth in earnings per share. By comparison, Chipotle put up impressive numbers last quarter, including 17% growth in comparable-restaurant sales and 24% earnings growth.
But, put simply, fast food isn't going away any time soon. And, if that's the case, then McDonald's won't go away any time soon either. It's true that McDonald's likely won't produce outstanding comparable sales growth as far as its domestic operations are concerned. However, that doesn't mean its days of growth are over.
That's because McDonald's is building on its promise to expand overseas, particularly in the emerging markets, where growth potential remains strong.
As part of the company's Plan to Win, McDonald's will spend $3 billion this year to open at least 1,500 new restaurants, the majority of which will be located in faster-growing economies in places like Asia, the Middle East and Africa.
Assuming it at least remains stable in the United States, there should be enough growth offered by these new markets to fund the company's core shareholder policies. These initiatives are what will propel future returns.
Reasonable returns still likely
It might seem ridiculous to think McDonald's could have much to offer, since its operating struggles have been documented so well throughout the financial media. And the truth is, McDonald's days of double-digit earnings growth may indeed be in the past.
But the other side of the argument is that McDonald's doesn't have to produce huge growth rates in order for investors to realize satisfactory returns. That's because of its reasonable valuation and compelling shareholder rewards.
In addition to its Plan to Win, McDonald's announced its intention to return a substantial amount of cash to investors over the next few years by leveraging its strong balance sheet. From 2014 to 2016, management will return $18 billion to $20 billion to investors through a combination of dividends and share repurchases. This represents a 10% to 20% increase from the amount of cash returned in the prior three-year period.
Meanwhile, Chipotle is on fire recently, but investors should be wary of buying a stock trading for 60 times trailing earnings and 40 times forward EPS, with no dividend.
McDonald's currently holds an earnings multiple of about 17, which is a slight discount to the broader market. Assuming the multiple does not contract, its 3.3% dividend yield and mid-single digit earnings growth would be enough to provide solid returns. Modest EPS growth is entirely likely, based on the billions in share repurchases, along with organic profit growth.
While McDonald's may not seem like an exciting investment, it should be able to satisfy any investor's hunger to grow wealth.