Dividend Aristocrat with Bullish Global Growth Prospects, Beaten Down Shares Offers Compelling Dividend and Capital Gains Play
McDonalds Corporation (MCD) is a franchising pioneer and global leader in the fast-food industry with 35,249 restaurants in over 100 countries, serving over 70 million customers every day. Of these, 28,691 restaurants are franchised to over 3,000 owner/operators and 6,738 are company owned and operated.
McDonalds was founded in 1940 with headquarters in Oak Brook, Illinois, and has over 440,000 employees worldwide (as of October 2014).
Recent Lackluster Share Price Presents Compelling Buying Opportunity
McDonalds’ shares have been range-bound over the past year ($90.53 to $103.78) and closed at $92.30 on 10/10/2014, up merely 0.60% over the past year, giving the company a market capitalization of $90.6 billion. With earnings of $5.52 per share, the company has a trailing-twelve-months price-to-earnings ratio of 16.7x and a Price/Cash Flow ratio of 12.55x.
On September 10, 2014, the company’s shares hit a new 52-week low of $90.53 in response to reports that its China meat supplier, Shanghai Husi Food Co., supplied expired chicken and beef to McDonald’s restaurants in the Asia Pacific region, forcing the company to pull products off its menu. Consequently, McDonalds Japan reported a 25% drop in year-over-year comparable store sales for August 2014 and a $157 million net loss, the first loss since 2003.
In response to the China snafu, Wall Street analysts dropped their share price targets and downgraded McDonalds’ shares, and urged the company to restructure operations, lower general and administration expenses and lower capital expenditures to help the company revive top-line and earnings growth.
So a series of missteps and mishaps, with broader market volatility over recent weeks, have moved shares lower to levels where they present a good buying opportunity for dividend and stability seeking investors.
Moreover, relative to its peers, McDonald’s has the lowest P/E ratio, the second-highest dividend yield and the third-highest net margin despite being overwhlemingly bigger than its competitors. The comparable valuation table below also supports the thesis that shares are under-valued and will reward long-term holders.
Consistent Dividend Increases Reflect Revenue Stability, Solid Cash Flow
McDonalds first declared a dividend in 1976 and has consistently increased dividends every year since, and is part of S&P 500’s Dividend Aristocrats index. The table below shows McDonald’s quarterly dividends for 2014.
McDonalds declared a Q4 cash dividend of $0.85 per common share (up 5% quarterly), payable December 15 to shareholders on record December 1, 2014. Q4’s dividend, annualized to $3.40 per share, delivers a dividend yield of 3.70% with shares at $92.30 on 10/10/2014.
Through dividends, the company has returned $3.2 billion to shareholders year-to-date (ending August 2014) and plans to return an additional $800 million in Q4. Management is committed to returning between $18 billion and $20 billion back to shareholders between 2014 and 2016.
Strategic Plan to Help Company Turnaround
McDonald’s established a five pillar “Plan to Win” to improve customer loyalty and revenue amidst increasing competition and government scrutiny on fast-food chains. The plan focuses on better serving customers localized needs, menu improvements with healthier eating options, high traffic restaurant locations with minimal overlap, competitive pricing and better branding. This framework will be adapted at the local level to bring about a better customer experience, grow loyalty and same-store sales, and increase long-term value to shareholders.
Loyalty Program Introduced to Bring Back Customers
Over the past six years, with the proliferation of healthier eating alternatives and greater choice, McDonald’s customer loyalty dropped from 91% to 83% and prompted management to introduce a loyalty program in October 2013. For the program, McDonald’s partnered with mobile solutions marketer Front Flip LLC and introduced its electronic loyalty rewards program ‘McD’ in 570 franchised stores across the U.S.
The McD mobile loyalty app is aimed at younger consumers and offers coupons with price reductions and free add-ons at participating stores. The app also rewards customers for filling out questionnaires related to their dining experience at its restaurants. A few franchises are also testing curbside pickup and mobile payments to cater to on-the-go customers.
Management also introduced a mobile version of its McDonald’s Monopoly sweepstakes in September 2014 to attract more customers.
Streamlined Menu to Improve Operational Efficiency
McDonald’s offers over 90 food and beverage products ranging from its classic hamburgers, cheeseburgers and chicken nuggets to new additions such as salads, wraps and chicken wings. Management brought the number of food and beverage products offered down from 145 items in 2007 in order to streamline the menu for better operational execution in response to complaints about the speed and efficiency of restaurant kitchens. A simpler menu, with condiments organized in an assembly-style operation, has helped the company reduce customer wait times.
Price Flexibility to Boost Profit Margins
In November 2013, McDonald’s revamped its “dollar menu” in response to increased competition and now offers several food, beverage and dessert options in the $1 – $5 price range. While typical value menus price products at $0.99 or less, McDonald’s chose a broader price range for its dollar menu to offer greater value and boost margins.
Introducing Build-Your-Burger to Counter Competitive Offerings
Starting in late 2013, McDonald’s began testing a Build-Your-Burger kiosk at a California restaurant and expanded this to three additional restaurants in August 2014. McDonald’s B-Y-B lets customers choose from 22 toppings, 3 cheeses and 2 buns. With this custom option, McDonald’s is borrowing a leaf from fast casual hamburger chain Five Guys, restaurant chain Chipotle Mexican Grill (CMG) and warm sandwich chain Potbelly Sandwich Works (PBPB), where the build-your-own concept has been highly successful.
This burger-building option is expected to attract new customers, improve worker efficiency, lower expenses and grow revenue. However, the plan is still in early test stages and could be several quarters away from full-scale roll-out.
New Partnership with Apple to Modernize Dining Experience
McDonald’s has partnered with consumer electronics giant Apple (AAPL) to accept mobile payments through Apple Pay at all U.S. McDonald’s starting in October 2014. Using near-field communication, customers with an iPhone 6, iPhone 6 Plus or Apple Watch can pay for food and beverage purchases through their mobile devices. This partnership is part of McDonald’s digital strategy to remain competitive and cater to the rapid explosion of smartphones.
Management Focused on Reestablishing McDonalds as Global Leader
Don Thompson serves as President and CEO of McDonald’s and has been with the company for 24 years in leadership positions including President – McDonald’s USA and Global COO.
Peter Bensen serves as Senior Executive VP and CFO and has been with the company for 18 years, with seven years in his current position. Bensen is responsible for financial risk, planning and data reporting. Bensen earlier held senior financial positions such as Director of Financial Accounting and Reporting, and Controller. He holds a Certified Public Accountant designation.
Tim Fenton served as McDonald’s COO from July 2012 to October 2014. He will retain his duties during a transitional period and act as Special Advisor to CEO Thompson after that period is over. McDonald’s will not assign a new COO and will restructure management. CFO Bensen will assume leadership over Worldwide Supply Chain, Development and Franchising while Executive VP and Global CBO Steve Easterbrook will assume leadership over the Restaurant Solutions Group, Corporate Strategy and Global CSR. Easterbrook has been with the company for 21 years.
Q2 2014 Financials Show Marginal Growth, Reflect 2014 Problems
For its second quarter ended June 30, 2014, McDonald’s had total revenues of $7.2 billion (up 1%), operating income of $2.2 billion (down 0.4%), net income of $1.4 billion (down 1%) and earnings of $1.40 per diluted share (up 1%).
Comparable sales decreased slightly in the U.S. and Europe due to negative comparable guest traffic while comparable sales increased in APMEA due to new store development and local promotions. Growth in total revenues was led by a 1% increase in sales by company-operated restaurants and a 3% increase at franchised restaurants.
As of June 30, 2014, McDonald’s had $3.7 billion in cash and cash equivalents, $14.9 billion in long-term debt and $16.2 billion in stockholders’ equity. The company had operating cash flow of $1.5 billion for the second quarter.
Comparable Sales Dip 3.7% in August 2014
On September 9, 2014, McDonald’s released a report on global comparable sales for the month and year-to-date ending August 31, 2014. For the month of August, the company experienced a 3.7% decrease in global comparable sales. Restaurants in the U.S. experienced a 2.8% decrease in comparable sales due to increased competition and slow food-service industry growth. Restaurants in Europe experienced a 0.7% drop in comparable sales due to weak performance in Russia as government officials closed 12 restaurants for sanitary violations after inspecting over 180 restaurants, part of Russia’s retaliation against U.S. sanctions. Restaurants in APMEA experienced a 14.5% comparable sales decrease due to supplier issues in China. Management expects supplier issues to lower Q3 2014 results by approximately $0.15 to $0.20 per share.
Year-to-date, McDonald’s experienced a 0.7% decrease in global comparable sales. Comparable sales decreased 2% in the U.S., increased 0.1% in Europe and decreased 2.2% in APMEA.
Management will release Q3 results before the market opens on October 21, 2014, with an investor webcast to follow shortly after.
McDonald’s is going through a near-term dip in customer traffic due to significant negative publicity on multiple fronts over the past year. Increased competition in the foodservice industry has also hurt comparable store sales. However, McDonald’s has leading global brand recognition and a clear plan to counter competitive pressure with Build-Your-Burger, McCafe offerings and loyalty rewards and mobile payment options. Moreover, once the China supplier issue dies down in public minds, McDonald’s brand will see higher sales and profits because of the fundamental soundness of its business model. For investors, McDonald’s high net margin, strong cash flow and consistent dividends provide a reliable source of income with an inflation-beating 3.62% dividend yield. The current slump in shares represents a significant buying opportunity into a temporarily beaten-down business that will bounce-back to feed the world’s growing population while increasing market share through healthier, more appealing dining options.