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Stay Invested In McDonald's

June 21, 2014 | About:
Faisal Humayun

Faisal Humayun

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McDonald's (MCD) global comparable sales for May 2014 might not have been very encouraging with sales in the US down by 1% and sales in Europe down by 0.4%. The offsetting factor was a strong increase in sales by 2.5% in Asia Pacific, Middle-East and Africa. This article discusses the reasons to remain invested in McDonald's with a long-term perspective.

More Penetration In Emerging Markets Will Drive Growth

As of 2013, McDonald's had 14,278 stores in the US, catering to a population of 330 million people. In comparison, China, with a population of 1.3 billion, had 1,957 stores and India, with a population of 1.2 billion, had 339 stores.

Going forward, these two markets will contribute significantly to the franchise revenue. It is certainly not that McDonald's products are not well accepted in these markets. The growth has just started and McDonald's has doubled the number of outlets in these countries in the last five years.

Going by the current demand, I strongly believe that this growth will continue for the company in the long-term from these two markets as well as other emerging economies (including Latin America).

Earnings And Dividends Have Been Growing

Even amidst the worst financial crisis in decades and a resulting slump in the global economy, McDonald's has continued to deliver on the EPS and dividends front. With the company doing well in the worst of times for the global economy, it might be a mistake to write-off the company when global GDP growth is picking up.

From a diluted EPS of $3.76 in 2008, McDonald's has reported a diluted EPS of $5.55 in 2013. This represents a 5-year CAGR of 8.1%, which is certainly robust.

From a dividend declared perspective, the growth has been equally robust with the dividend increasing from $1.63 in 2008 to $3.12 in 2013 representing a 5-year CAGR of 13.9%. For the first quarter of 2014, McDonald's announced a dividend of $0.81 per share and this translates into an annualized dividend of $3.24, representing another increase of 3.8% in dividends for 2014 as compared to 2013.

McDonald's has been creating shareholder value on a continued basis and I believe that the company’s growth in emerging markets will keep the value creation going even if revenue grows at a muted pace in emerging markets.

A High 3-Year Cash Return Target

McDonald's intends to boost shareholder value creation with a strong 3-year cash return target in terms of dividends and share repurchase. The company intends to return $18 to $20 billion to shareholders between 2014 and 2016 through a combination of dividends and share repurchases, representing a 10% to 20% increase over the amount of cash returned between 2011 and 2013.

The cash return target on the high end is very likely considering the fact that McDonald's had a robust cash position of $2.8 billion as of December 2013 along with an annual operating cash flow of $7.1 billion. With $2.8 billion in capital expenditure, a high free cash flow of $4.3 billion ensures that the company is in a strong position to carry out share repurchase along with the payment of dividends.

Conclusion

At a current market price of $101.9, McDonald's is offering a good dividend yield of 3.2% and it is very likely that the dividends will increase given the company’s current shareholder value creation strategy.

Besides the dividend factor, McDonald's is also attractive from the perspective of strong fundamentals and a low beta. I believe the equity markets are stretched at this point of time and a low beta of 0.36 for McDonald's makes it an attractive investment choice from the perspective of capital preservation along with stable dividends.

McDonald's stock has inched up marginally by 5.7% in 2014 and further stock upside is very likely given the company value creation plans for shareholders coupled with continued expansion in high growth markets.

About the author:

Faisal Humayun
Senior Research Analyst with experience in the field of equity research, credit research, financial modelling and economic research

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