McDonald’s (MCD, Financial) stock price has been on a tear, surging nearly 40% in a short period of 12 months. The world’s No. 1 restaurant chain in terms of revenue and size has truly turned things around, taking several steps that have boosted investor confidence. But revenue is still declining and will continue to decline further as the company continues the path to achieve a 95% franchised restaurant ratio - a long way to go from the current level of nearly 85%.
If you have been following my articles, I have been a great advocate for buying into McDonald’s, especially for dividend investors who are looking for stable companies that can keep paying dividends and keep increasing them for a long time.
As a highly franchised company, McDonald’s will have stable revenue streams that include the payment of rent, initial fees paid for opening a new restaurant and ongoing royalties. This makes for extremely stable cash flow, but also makes it harder for McDonald’s to grow its revenues, as it will require opening a huge number of restaurants, which is extremely difficult for a company that already has more than 36,000 stores spread across 100 countries.
The effect of this transition towards becoming a highly franchised restaurant chain is already visible in McDonald’s financial statements. As you can see from the table above, McDonald’s revenue has been coming down at a fast pace. Between 2011 and 2016, McDonald’s revenue declined by $2.384 billion, mainly due to revenue from company-operated restaurants declining by $2.998, offset by $614 million revenue growth from franchised restaurant sales.
The most important factor to note here is that the number of franchised restaurants increased by a whopping 4,155 units during this period, while company-operated restaurant units decreased by 766 units, for a net sales drop of $2.384 million. McDonald’s had an franchised restaurant ratio of 84.6% at the end of 2016, and it still has a long way to go before it can hit the ultimate goal of 95%.
Revenue is highly likely to keep declining till McDonald’s reaches that point, which is exactly why the current 5.42 times sales at which McDonald’s is trading is understated. That number will keep increasing as sales continue to decline every quarter over the next few years.
MCD data by GuruFocus.com
McDonald’s smartly announced a 7% dividend increase on Sept. 21. With that, McDonald’s has now increased dividends for 41 years in a row, and it will continue to add many more years to that record. The sharp rise in dividends has further fueled the stock surge, and I expect the stock price to raise further until some bad news hits.
There is no question about the longevity of the business and the low-risk nature of cash flow, but don’t chase McDonald’s if the stock price keeps moving up. It’s better to wait for things to cool down before buying into the company.
Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.
