McDonald's Remains An Excellent Long-Term Buy

Summary

• Momentum was once more to the fore in Q4 earnings.
• Earnings projections for 2020 and 2021 continue to increase.
• We look at the state of the dividend.
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The rout in US stocks seems far from done yet as the VIX (Volatility index) once again today (March 9th) finishes on a higher high. The question for investors here at present is where will stocks bottom. Given the sheer collapse of stock prices over the past while, it remains possible that the 4-year cycle low in the S&P is still ahead of us. Remember, those lows eventually bottomed below $2.400 a share, so we may have significant down-side still to go here in the S&P.

Warren Buffett once said,

Only when the tide goes out do you discover who's been swimming naked.

The lower equity markets go, the more you are going to see how too much leverage can expose even the best of companies. One such company, though, which definitely has stood the test of time when it comes to shareholder returns has been McDonald's (NYSE:MCD). The company has now raised its dividend for 43 straight years, and the model seems to be going from strength to strength.

We state this because the fourth quarter reported almost 6% global comp sales. This is really encouraging, given the fact the comps have now grown consistently every quarter for the past 4 years. A few milestones were mentioned on the fourth quarter earnings call by new CEO - Chris Kempczinski.

• $100 billion in system-wide revenues took place in 2019.
• Global comp sales grew by 5.9%, which was the restaurant chain's best growth number in 10+ years.
• The US market (largest by far for MCD) grew comps by 5% in 2019, which was its best growth number for 13 years.

McDonald's continues to defy the odds as its successful model continues to be leveraged for maximum results. At present, MCD trades with a forward earnings multiple of 23.4, which is just below its 5-year average of 24.4.

Now, some long-term investors may state that this valuation is not cheap enough, considering the carnage equity markets experienced recently. However, here is what an investment in McDonald's will give you in spades.

• Earnings predictability. It is earnings which primarily drive stock prices on Wall Street. McDonald's actually increased its earnings back in '08 and '09 when other "cheaper" chains were going to the wall. The bullish forward-looking earnings projections once more should limit volatility in the share price.
• Even if MCD shares gets caught in a potential significant downdraft, we believe this stock (maybe along with Walmart (WMT)) would be bonkers for increasing their dividends. This once more would iron out some of that potential sustained volatility if it were to arise.

In fact, if we look at the long-term chart of McDonald's, the last time MCD shares underwent high levels of volatility was back in 2002-2003. Since then, the 50-month moving average has only been tested in 2015 but has never been breached. Considering the given trends mentioned above, it would take a brave investor to state that this time will be different.

With respect to the dividend, management paid out $3.58 billion in 2019 out of a free cash flow kitty of $5.72 billion. This gives us a pay-out ratio of 62%, which is more or less what we look for. When the pay-out ratio is too high, future dividend growth is a concern. When it is too low, it usually means shareholders are not getting their fair share. Some investors may allude to the fact that the company has been issuing a lot of debt recently, and negative shareholder equity has been increasing on the balance sheet. However, management has been more aggressive in buying back its own stock. For example, Treasury stock reached $66.32 billion in 2019 whereas total liabilities hit $55.72 billion in the same period. Suffice it to say, don't let the lack of reported equity deter you from potentially investing in McDonald's.

Therefore, to sum up, given the ease at which McDonald's can generate cash flow along with the projected 8% run rate with respect to forward-looking earnings, we see it very likely that at least high single-digit growth will continue in the dividend. Any more weakness in the share price is an opportunity to keep on reinvesting those growing dividends. Over the long term, we see minimal downside risk here.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.