The S&P 500 currently has a price-earnings ratio of 24, giving the index one of its more expensive valuations in quite some time. Knowing this, it is not surprising that there are many stocks in the market that carry an elevated valuation.
An elevated valuation could mean that the stock is overbought, or it could mean that the market recognizes that the underlying company is outperforming competitors (which could mean that the high price-earnings ratio is nothing to worry about).
After reviewing the company’s performance and dividend history, it seems to me that McDonald’s Corp. (MCD, Financial) belongs to the latter group.
Company background and recent financial results
McDonald’s is divided into four business segments: U.S. market (where the company has more than 14,000 stores), International Operated Markets (which includes developed markets such as France, the U.K., Canada and Australia), International Developed Licensee (which includes high-growth markets such as China, Spain, Italy and Russia) and foundation markets and corporate (which are markets outside of the previously listed markets and corporate activities). McDonald’s has a market capitalization of $162.5 billion and generates slightly more than $21 billion in annual revenues.
McDonald’s reported its fourth quarter and full year results on Jan. 29, 2020. Earnings totaled $2.08 per share for the quarter, which was 8 cents above estimates and represented a 14% increase from the previous year. Revenue for the quarter improved 3.6% to $5.35 billion, which topped estimates by $50 million.
This was the second consecutive quarter that revenue grew year-over-year. That may not seem that impressive, but the past two quarters are the only quarters in the last five years that have seen revenue growth. Much of the revenue decrease in the past can be explained by the company’s decision to refranchise the majority (approximately 93%) of its restaurants. This has lowered revenue, but reduced the company’s costs at the same time.
For the full year, earnings increased 5% to $7.88 while revenue of $21.1 billion was essentially flat. In constant currency, EPS was up 7% and revenue improved 3%.
What should really excite investors regarding McDonald’s are its same-store sales results. Global comparable sales for locations open at least one year were up 5.9% in the fourth quarter, beating consensus estimates of 5.3%. As has been the case for some time, international markets led the way. The International Operated Markets segment grew 6.2% in the quarter and the International Development Licensee segment was up 6.6%. U.S. comparable store sales were up 5.1%.
The story for 2019 as a whole was largely the same. Same-store sales for the year were higher by 5.9% companywide. The International Development Licensed segment increased 7.2%, while the International Operated segment was higher by 6.1% and the U.S. was up 5%.
Making matters even more impressive is that these comparable sales were made on already strong numbers from the previous year. Same-store sales for the fourth quarter of 2018 grew 4.4% from the prior year. Comparable sales for 2018 had growth of 4.5%.
This means that McDonald’s had a two-year stacked same-stores growth of 10.3% for the fourth quarter and 10.4% for the year. There aren’t many quick services restaurants able to produce that type of growth.
Sales growth was pretty strong right out of the gate following the all-day breakfast initiative in 2015, but the last two years have been especially impressive. Clearly, McDonald’s has more going for it than just the ability to sell breakfast at any time of the day. It takes a strong performance throughout the business to generate this type of same-store sales growth.
The U.S. saw growth in every part of its business. A higher average ticket more than offset a decrease in traffic. Locations that offer "Experience of the Future" performed better than others. Some perks of the "Experience of the Future" include mobile and kiosk ordering as well as delivery. Almost 10,000, or 70%, of U.S. stores offer these options as of the end of 2019. The remainder should be updated by the end of 2020.
Delivery has also become an important component of operations. This service began three years ago and has transformed from a $1 billion business to more than $4 billion in 2019.
Same-store sales in the U.K. have now increased for 55 consecutive quarters. For almost 14 years, McDonald’s has had higher sales every quarter as the company has managed to match its menu to its customers' tastes.
In France, comparable sales were up for the 11th straight quarter as McDonald’s has reached its highest ever capture of market share in the country.
Brazil, China and Japan were the largest contributors to growth in the International Developed Licensee segment.
Analysts expect McDonald’s to produce EPS of $8.95 in 2020, which represents 13.6% growth from last year and is above the company’s 10-year average EPS growth rate of 5.4%.
Quarterly and full year results show that McDonald’s continues to offer customers value and options that are causing same-store sales to increase at a high clip in nearly every market that the company operates.
Dividend and valuation analysis
McDonald’s is a Dividend Aristocrat, having increased its dividend for more than four decades. The company has increased its dividend by an average of:
- 9.4% per year over the past three years.
- 7.6% per year over the past five years.
- 8.7% per year over the past 10 years.
The company most recently increased its dividend by 7.8% for the Dec. 16, 2019 payment, marking 44 consecutive years of dividend growth for McDonald’s. There aren’t too many other companies that have a longer track record of dividend growth. The company has experienced four separate recessions and still managed to raise its dividend.
McDonald’s is projected to pay out $5.00 in dividends per share in 2020, which would represent an EPS payout ratio of 56% using EPS estimates for the year. This is a very reasonable payout ratio and in-line with the 10-year average payout ratio of 58%.
Examining the company’s free cash flow, it appears that the dividend will likely continue to grow in the coming years. McDonald’s paid out $3.6 billion in dividends in 2019 while producing $5.7 billion in free cash flow for a free cash flow payout ratio of 63%. From 2016 through 2018, the company distributed $9.4 billion in dividends while generating $12.2 billion in free cash flow for an average free cash flow payout ratio of 77% over this period of time. This means that the most recent year saw a significant improvement in free cash flow.
If there is a downside to buying McDonald’s at the current price, it’s the stock’s valuation. Based off of the recent closing price of $216 and EPS estimates for 2020, shares of the company trade with a price-earnings ratio of 24.1. This is above both the stock’s five and 10-year average price-earnings ratios of 22 and 19.6, respectively.
Final thoughts
Shares of McDonald’s can be considered expensive today, no doubt, but the company just completed a quarter and year that saw impressive comparable sales growth. Even better, the two-year stack growth rate reached double-digits. The company saw growth in all of its segments. McDonald’s is also revamping its remaining stores to offer guests a more improved experience. Delivery, a relatively new service, is just starting to take off and has proven quite successful in a short period of time.
Some stocks in this market haven’t earned an elevated price-earnings ratio, but from my viewpoint, a company like McDonald’s deserves to have a valuation reflective of these factors.
Disclosure: Author is long McDonald’s Corp.
Read more here:
- Buy AbbVie for Its Growth Prospects, Yield and Low Valuation
- Intel: An Undervalued Stock Offering Potential Double-Digit Returns
- Johnson & Johnson is the Quintessential Recession Proof Company
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
