Though I will eventually get around to analyzing Canadian dividend growth stocks, I am presently involved in screening my current U.S. stocks. Though I performed in-depth reviews of each of my holding prior to investing, I am interested in keeping track of the current valuation and technical signals of stocks in my portfolio to identify appropriate accumulation and divestment points as they occur. To continue with this portfolio evaluation, the following presents an analysis of McDonald’s Corp – the world’ largest fast-food company.
10 Year Company Performance
Examining historical financial statements for MCD, select 10-year compounded annual growth rates (CAGR) are as follows:
- Revenue: 6.2%
- Earnings: 16.7%
- Book Value: 7.6%
- Free Cash Flow: 23.6%
- Dividends: 30.6%
A plot of the historical earnings, free cash flow, and dividends paid is presented below. Note how earnings and free cash flow track each other and remain consistently above the dividends paid.
From the above results, it can be seen that McDonald’s has produced exceptional results over the past 10 years with earnings, free cash flow, and dividends all growing at rates in excess of 15%.
Though MCD has a very strong 10-year growth record, it is unlikely that they will be able to produce the same type of growth into the future. To provide a margin of safety for the investment, the following projections from have been used for continuing business growth:
- Revenue: 6.0%
- Earnings: 9.0%
- Book Value: 7.5%
- Free Cash Flow: 7.5%
- Dividends: 9.5%
As can be seen, consensus estimates for future growth are less than the historical growth rates, but still high enough to provide the opportunity for significant returns in the future.
Return on Equity:
Looking at MCD’s return on equity (ROE) for the last 10 years (see Table 1 below), we can see that it has averaged 19.6% which is approximately equal to the 20% average that I am looking for. However, in 2002 the ROE decreased to 8.7% which is below my 15% minimum. At this time, McDonalds entered into a corporate restructuring with the appointment of a new chairman and CEO and a renewed corporate focus. Since this restructuring, MCD’s operating results have improved with an average ROE of 22% and a minimum above 15%. Though MCD does not meet my strict criteria for ROE, their performance since restructuring has been exceptional and as such MCD is awarded a star in this metric.
Dividend Income vs. Fixed Income:
To determine the relative attractiveness of MCD’s dividends to the income from long corporate bonds, a Net Present Value (NPV) calculation of the difference between the two income streams has been completed. For this calculation, MCD’s current yield of 2.8% was adopted along with the assumed dividend growth rate of 9.5% per year. The interest on comparable long corporate bonds was set to 5.2% per annum.
Using this data, over a 20-year investing horizon the NPV of the dividend stream in excess of the interest on the long corporate bonds is calculated to be $533. As the income received from dividends is greater than the interest received from a comparable fixed income investment, MCD is awarded a star for this income metric.
Dividend Payout Ratio:
As dividends are paid out of free cash flow, it is important to ensure that companies generate enough free cash flow to allow them to continue to pay their quarterly dividend while reinvesting in the business. Over the trailing 12 months (TTM), MCD has generated $3.74 in free cash flow per share (fully diluted) while paying out $2.20 in common dividends. This results in a free cash flow payout ratio of 59% which is near the high end of my acceptable range. Over the last 10 years, the free cash flow payout ratio has averaged 41.5% and has generally remained close to the 50-60% level over the last 4 years.
Over the last 10 years, MCD’s rate of earnings reinvestment has averaged 18.8%. Even with the relatively high payout ratio, this rate of reinvestment leaves a margin of approximately 20% for future dividend increases (an 11% increase has been announced for Q4) and share buyback programs discounting any projected growth in free cash flow.
Table 1: Select Historic Data: ROE & Free Cash Flow Payout
|Year||Return on Equity||Free Cash Flow||Dividends Paid||Payout Ratio|
Balance Sheet Leverage:
The use of leverage (debt) by corporations can be a good way to increase their rate of return. However, taking on too much debt can be hazardous and can result in significant losses over time if not managed properly. As a measure of the leverage of the balance sheet, the debt-to-total capital ratio indicates the ratio between the debt and the debt and shareholder’s equity on the balance sheet. MCD’s debt to total-capital is 45.6% which indicates a moderately leveraged balance sheet.
Corporations with leveraged balance sheets tend to have a high return on equity. By examining the return on assets ratio, a measure of the leverage employed can be gained. Over the past 10 years, MCD has averaged a 9.3% return on assets (ROA) which I consider average.
Based on the analysis of these free cash flow payout and the balance sheet leverage, MCD is considered to have sufficient coverage for their dividend and a moderately leveraged balance sheet. Though both of these metrics are near the upper end of what I consider to be acceptable ranges, MCD is awarded a star for their performance in these metrics.
Summary of Fundamental Metrics
Based on the Return on Equity since their corporate restructuring in 2003, a dividend payout that should outpace the interest income from corporate long bonds, and a sufficiently covered dividend payout and moderately leveraged balance sheet, McDonalds has been awarded 3 out of 3 stars in the fundamental analysis metrics that I track.
In my next post, I will look at McDonald’s valuation metrics compared to the current price.
Until next time,
Nathan @ EngineeringIncome.com
The data and opinions presented above are for educational purposes only and should not be construed as individualized investment advice or as a recommendation to buy or sell the securities in question. The investing methodology outlined on this site assumes that a stock will perform in the future as it has in the past. This is generally not true. It is the responsibility of individuals to perform their own due diligence and/or consult their investment adviser to determine the suitability of any given investment product for their specific situation. For more information, please see my disclaimer.
Full Disclosure: Long MCD at the time of this writing.