Time To Buy McDonald's

| About: McDonald's Corporation (MCD)

Shares of McDonald's (MCD) have declined 12% from its 52-week high of $102.22 achieved in January. At $89.70 per share, the stock has a decent 3% dividend yield and the valuation is very close to its 52-week low measured by NTM P/E (see below). I believe the drop has created a great buying opportunity for this quality long-term dividend investment as the stock price appears to be cheap now.

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In this article, I will illustrate the rationales that support my bullish view on this dividend investment.

My value analysis includes a set of publicly-traded restaurant chain as MCD's comparable peers. The estimated MCD stock value is then determined by weighting the valuations calculated by five peer average multiples. As MCD is a well-established global firm, valuation multiples such as EV/FCF, EV/EBITDA, and P/E are relatively more relevant, and thus they are assigned a 25% weight each. Other less relevant multiples including P/S and EV/Sales are weighted 12.5% each.

The following three paragraphs are based on the table shown below:

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As MCD is relatively more matured than its comparable peers, the growth potential appears to be below peer average. Consensus estimates predict revenue, EBITDA, and EPS to rise by a 2-year CAGR of 3.9%, 5.4%, and 6.9% over the current and next fiscal years, which are less than those of peers.

Nonetheless, MCD has demonstrated a superior profitability and capital return. Its gross, EBITDA, EBIT, and net profit margins are the highest among the group. Its ROE is also substantially higher than peer average, but ROIC is fairly in line.

Moreover, MCD's liquidity measures also suggest a healthy and strong balance sheet. Its LTM FCF margin is the highest in the group. Despite an above-average leverage level, MCD is still able to maintain a strong interest coverage rate. The current and quick ratios are also fairly in line with the group.

As such, I believe MCD stock should warrant a decent premium valuation to account for its strong global presence and brand equity, as well as the healthy financial condition. Since the current stock price of $89.70 only implies a 6.1% valuation premium (see below), I expect there remains a solid price upside down the road.

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In addition, MCD's annual dividend per share has grown at a 10-year CAGR of 27% (see below), reflecting management's strong commitment to returning capital to shareholders.

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The current dividend payment also appears to be sustainable down the road. Historically, annual dividend payment only represents about 60% of the total annual free cash flow (see below). As MCD's FCF continues growing, the dividend growth is likely to be sustained.

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According to the table shown below, EBITDA margin has improved from 31.8% in 2008 to 35.9% in 2011. It is also expected to rise to 37.4% by 2014 (see below). Moreover, MCD has been able to maintain a stable EBITDA to operating cash flow conversion rate at around 73.5% over the past three years (see below), suggesting the current FCF margin is to at least remain stable down the road (assuming stable CapEx).

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On the technical side, MCD stock has been recently trying to break through its 30-day simple moving average, which serves as a psychological price ceiling since the beginning of this year (see below). Once the stock has established a ground above the 30-day SMA, I would expect an upward price action going forward.

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Bottom line, in the light of attractive valuations and sustainable dividends, I strongly recommend investors taking the current price benefit to establish a position in MCD.

Price and P/E charts are sourced from Capital IQ, analysis tables are created by author, and all financial data is sourced from Capital IQ and Morningstar.

Disclosure: I am long MCD.