Overview

McDonalds Corporation does not really need an introduction. The company behind the Big Mac sandwich is one of the largest food service retailers in the world, serving each day more than 69 millions customers in more than 115 countries. McDonalds Corporation manages more than 34,000 restaurants, either directly or via independent franchisees.

The McDonalds Corporation we know today has been founded in 1955 when Ray Kroc incorporated his company and opened his first franchise after acquiring the rights from the McDonald brothers. Since then, McDonalds Corporation has grown to become a large multinational company having a market cap of almost $98G and having operations in more than 115 countries.

McDonalds Corporation is headquartered in Oak Brook, in the state of Illinois, USA.

Shares of McDonalds Corportation are traded on the New York Stock Exchange (NYSE) under the ticker “MCD”.

MCD is classified in the consumer discretionary sector according to the Global Industry Classification Standard (GICS ).

Dividend Calendar

MCD pays dividends four times per year.

MCD generally declares its dividends in January, May, July and September, and generally pays its dividends in March, June, September and December.

MCD typically increases its quarterly dividend once a year, in September. The last increase, in September 2012, was of 10.0%.

MCD has increased its dividend for 36 consecutive years, making it a dividend champion, i.e. more than 24 years of consecutive increases.

Dividend History

The graph below shows the last ten years of annual dividends with the last 9 years of annual dividend increases.

As we can see, though the dividend has been growing relatively steadily over the last ten years, the annual dividend increase has been random at best. Still, more recently, since 2010, the annual dividend increase has been much more stable between 10 and 15%. I expect future increases to be along this recent trend.

Dividend Health

• Earning growth (10 year average): 18.65%
• Free cash flow growth (10 year average): 13.38%
• Dividend growth (10 year average): 24.48%

The evolution of the earnings, dividends and earning payout ratio over the last 10 years is presented below.

Key points

• Over the last 10 years, the earnings have been growing mostly steadily (a small drop in 2007).
• Over the last 10 years, the dividend has been growing steadily.
• Over the last 10 years, the payout ratio has been slowly rising (the dividend has been growing faster than the earnings).
• The payout ratio is high but reasonable between 50 and 60%.

Conclusion

• The dividend appears safe (reasonable payout ratio);
• Since the payout ratio is already between 50 and 60%, the dividend growth rate will likely slow down to allow the earnings to catch up.

The evolution of the free cash flow, dividends and free cash flow payout ratio over the last 10 years is presented below.

Key points

• Over the last 10 years, the free cash flow has been generally growing, but not steadily.
• Over the last 10 years, the dividend has been growing steadily.
• Between 2003 and 2005, the payout ratio was stable around 30%.
• Between 2005 and 2009, the payout ratio has grown from about 30% to about 60%.
• Between 2009 and 2011, the payout ratio was stable around 60%.
• In 2012, the payout ratio topped at nearly 75%.
• The payout ratio is high at 75%.

Conclusion

• The dividend is not in danger but future dividend growth might be limited (high payout ratio);
• Since the payout is high at 75%, the dividend growth rate will likely slow down to allow the free cash flow to catch up.

Stock Valuation

To calculate a fair value for MCD, I calculate how much one share will return in cumulative dividends over the next 20 years, adjusted for inflation.

For MCD, I’ve used the following inputs:

• Share price: $98.00
• Dividend rate: $3.08
• Dividend growth rate:

• Optimistic scenario: 24.0%
• Realistic scenario: 19.2%
• Pessimistic scenario: 14.4%

The optimistic DGR generally corresponds to the 10-year average, while the realistic and pessimistic DGRs respectively correspond to 80% and 60% of the optimistic DGR.

According to the inputs, the estimated fair values of MCD range from $187.41 (pessimistic) to $561.70 (optimistic) with a realistic value of $320.92.

With a current share price at about $98.00, MCD appears significantly undervalued. However, in view of the recent dividend history, it is unlikely that MCD will maintain a DGR of even 14.4%. A DGR around 10% is more likely.

Still, I’ve calculated that the DGR would need to be 8.30% over the next 20 to justify the current price of $98.00. Hence, at the current price, MCD would appear fairly valued.

Estimated Cash Return

To calculate the ECR of MCD, I’ve taken the following inputs:

1. Initial investment: $1000
2. Current yield: 3.14%
3. Estimated dividend growth rates:
4. Optimistic scenario: 24.0%
5. Realistic scenario: 19.2%
6. Pessimistic scenario: 14.4%

Notably, the estimated DGRs are the same as the DGRs used for valuation.

As indicated above, it is very doubtful that MCD will be able to maintain a DGR of 14.4%, much less of 24.0%.

However, if MCD manages to maintain a DGR around 14.4%, MCD will return more than $12k over the next 30 years. Thats great.

Still, for the sake of the exercise, Ive calculated the ECR should the DGR be 8.30%, the DGR calculated above to justify the current valuation. With such a DGR, the ECR over 30 years would be a more probable $3,7k. Still not bad.

Currency and Withholding Tax Considerations

MCD is a US corporation and pays its dividends in US dollars.

For US residents, there is no withholding tax.

For Canadian residents, the basic withholding tax rate of 15% will apply unless the shares are held in a registered account.

For foreign residents, the basic withholding tax rate of 15% will likely apply (assuming that a tax treaty exists).

Conclusion

MCD pays a generous dividend and has a long history of increasing it. For that, MCD would be a great dividend stock.

However, the dividend has been growing faster than the earnings and free cash flow, which has caused the payout ratios to reach somehow high levels. Though the dividend does not appear to be in danger, I think that future dividend increases will be much lower than the last 10-year average.

Still, even at a more likely 10%, such a DGR would justify the current stock price of about $98.00. However, the current stock price does not provide any margin of safety should the future DGR be lower.

MCD will thus remain on my watchlist.

However, I might consider adding to my position if the stock price drops below $95.

What about you. Would you buy MCD at the current price?

Full Disclosure

I currently own shares of MCD.