McDonald's Dividend: Double-Digit Growth At Value Meal Prices

| About: McDonald's Corporation (MCD)
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McDonald's Corporation (NYSE:MCD) franchises and operates McDonald's over 33,000 fast-food restaurants, with the majority (81%) operated by franchises or affiliates. Their restaurants serve a broad menu at various price points to customers in 119 countries around the world.

McDonald's has not only increased its dividend every year over the past decade, it has done so at a double-digit rate each year excluding one. It is yet another example of companies that have been able to generate cold hard cash for their shareholders, even through the Great Recession, and in the slow recover that has followed.

Below are McDonald's historical dividends and growth rates for the past 10 years:

Year Dividend Dividend Growth
2002 $0.24 --
2003 $0.40 67%
2004 $0.55 38%
2005 $0.67 22%
2006 $1.00 49%
2007 $1.50 50%
2008 $1.63 9%
2009 $2.05 26%
2010 $2.26 10%
2011 $2.53 12%

Based on the data below, McDonald's large dividend increases in the beginning of the decade were primarily driven by an expanding payout ratio. However, the company also did an outstanding job of growing free cash flow per share, which grew at a compounded annual rate of +13% over the past 5- and 10-year period.

Furthermore, the payout ratio has still been under 40% for the past few years, indicating that there is strong cash flow to support the current dividend, as well as potential increases in the future. For example, if McDonald's held the same payout ratio constant and continued to grow FCF/share at the same rate, it could likely continue to increase the dividend 10-15% annually.

Year FCF/Share Payout Ratio (Div/FCF per share)
2002 $2.16 11%
2003 $2.36 17%
2004 $2.88 19%
2005 $2.98 22%
2006 $3.43 29%
2007 $4.06 37%
2008 $4.85 34%
2009 $5.22 39%
2010 $5.92 38%
2011 $6.77 37%

Dividend Discount Model

Using the dividend discount model, I determined the value of the company based on its future dividend payments. In performing this valuation, I made several assumptions. First, I used 9% as my discount rate, based on the long-term average return of the stock market.

Next, I used McDonald's 2011 dividend as the base to apply future growth rates to, rather than adjusting for the 15% increase announced last December. This seemed like a more consistent and straightforward approach considering the company tends to announce dividend increases in December.

I applied a constant growth rate of 14% for years 2012-14, a 12% growth rate for 2015-17, and a 9% growth rate for 2018-2021. Finally, I assumed a 5% perpetuity rate after 2021.

Based on these assumptions, I calculated that McDonald's intrinsic value is $112 per share. At the current price of $88.38/share, the stock is ~21% below its intrinsic value. Hence, the current price offers investors a large margin of safety for a large company with a long track record.

In addition, the current price assumes a constant growth rate of 6.1% for the stock's dividend. While this would be considered fair to high for many companies, I believe this rate is too low given the company's past and recent performance. Therefore, long-term, income-oriented investors may want to give McDonald's a closer look to see if it should be included in their portfolio.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the dividend growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.