McDonald's Corp. (MCD) recently reported another terrific quarter. Management's decision to keep increasing the dividend continues to maintain shareholders' respect. The dividend continues to assist in helping the stock's annualized total rate-of-return numbers. I'll address key third quarter developments and why the dividend should continue to increase for years to come.
Dividend Rate and Growth
On September 22nd, McDonald's announced a quarterly cash dividend of 70 cents per share. The dividend is payable on December 15, 2011. This is a 15% increase based upon the prior quarter. The company will pay out $700 million in 4th quarter dividends.
The $2.80 annual dividend represents a 3.0% dividend yield. This payout is fairly high considering the company increases its dividends on a regular basis. This rate will likely continue to grow as the company places importance on share repurchases. The company will likely buy back approximately $3 billion of its shares in 2011.
Third Quarter Results
McDonald's announced third quarter earnings of $1.45 per share. This is a 12% year-over-year growth rate. The company's revenues came in at $7.17 billion.
The company should earn approximately $5.25 per share for 2011. This represents an 18x price-to-earnings (P/E) multiple. Historically the company has traded at a 14x - 20x P/E multiple.
Enhanced Income Strategy
For current McDonald's shareholders, I recommend considering an enhanced income strategy. Close to 75% option buyers expire worthless. To arrive at a higher income level, I suggest a couple of solutions for enhanced income.
These strategies should only be used by investors who recognize the risks and rewards with puts and calls. The stock is currently trading at $92.01. Based upon this price, I recommend two option trades:
1. Sell one MCD January 2012 $95.000 call (MCD120121C00095000) for a $162 credit to your brokerage account. As long as McDonald's remains under $95 by January 20th, 2012, then you will pocket the $162 credit as option premium income.
I don't want to give up my McDonald's shares. In the event McDonald's is above $95 on January 20th, then I will roll over the option trade. For example, I may sell an April $110 call and close out the short January call. This is all done at the same time to reduce friction costs and maximize my net enhanced income return.
2. Establish a vertical put spread. This involves two trades. I personally prefer to never sell a put without a quantitative knowledge of worst case scenario. At $92 per share, I want to minimize the maximum pain.
Sell one MCD January 2012 92.500 put (MCD120121P00092500) for a $390 credit to your brokerage account. At the same time, buy one MCD January 2012 82.500 put (MCD120121P00082500) for a $110 debit. This trade will provide a net $280 credit ($390 credit minus $110 debit = $280 credit) to your brokerage account.
Let's examine this option closer. If McDonald's remains above $92.50 when January arrives, then I net $280 credit.
In the worst case scenario, let's assume McDonald's is trading at $80 on January 20th, 2012. In this case I am out ($92.50 - $82.50 = $1,000 debit) $1,000 but I have a $280 credit to offset the $1,000 debit. Thus the outlay would be $720 debit. If we factor in the $162 credit from trade number 1, the $720 debit would be reduced by $162. The end result would be a ($720 debit minus $162 credit = $558 debit) $552 debt, or a cash outlay.
We can roll this vertical put spread over to a future month. We will have plenty of choices to achieve enhanced income, reduce friction costs, and retain our McDonald's shares.
Competition
The below table shows McDonald's outperforms the competition. Only Chipotle Mexican Grill, Inc. (CMG) had a higher 5 year total annualized rate-of-return with a 44.1% average. Not surprisingly, McDonald’s owned a 91% interest in Chipotle through 2006. Chipotle then had its own IPO and the rest is history.
Chipotle Mexican Grill, Inc. (CMG) has zero debt on its balance sheet. Estimates are for 15-25% growth. This company is working its magic like McDonald's did in the early years.
Wendy's Company (WEN), in my mind, is a pure play competitor to McDonald's. It is true they aren't equal, but growing up it was always Wendy's or McDonald's for a quick meal. Based upon my personal experiences, Wendy's customer service severely lags McDonald's staff. If one has children, McDonald's has everything children seek: Toys, games, a game room to crawl in, and food with prizes. Wendy's does not offer these incentives.
Tim Hortons Inc. (THI) has operations both in Canada and the U.S. Over 3,000 restaurants are in Canada and over 600 in the U.S. The company's growth has slowed, although it continues to expand. I would like to see the dividend grow a bit faster. The company is a fast food enterprise.
Jack in the Box Inc. (JACK) is a fast food business. Earnings have been flat for about 10 years. The business has about 2,000 stores and the company doesn't pay a dividend. I'll pass on this name.
Darden Restaurants, Inc. (DRI) operates upscale fast food restaurants. These include Olive Garden and Red Lobster. The company pays a decent dividend and operationally is impressive. I would prefer to buy the equity at the $35-$40 range. In today's economy, many families are stepping down from high-priced restaurants to the more reasonably priced Darden outlets. I like the stock, but at lower prices.
Summary
McDonald's is a corporate money making machine respected by most income investors. It is growing globally. As with any environment, certain areas are growing faster than others. For the third quarter, total global comparable sales increased by 5%. The United States was up 4.4%. Monday McDonald's announced plans for the McRib kickoff. The McRib will be sold through November 14th in the U.S. Europe showed a strong quarterly increase of up 4.9%. Asia/Pacific, the Middle East, and Africa indicated a 3.4% rate.
Please don't forget to consider the long term. Latin America is a growing population with an increase in income and lifestyle. Arcos Dorados Holdings (ARCO) is a company that provides royalties to McDonald's. For background, here is a prior article of mine on Arcos Dorado.
