McDonald’s Stock (NYSE:MCD)
One of our favorite stocks to consider in this market scenario is the titan of fast food and dividend growth, McDonald’s (NYSE:MCD), for several reasons.
McDonald’s benefits from additional revenue from its franchisees and is largely protected from labor and food cost inflation because of its mostly franchised business model.
The company offers exceptional value to customers, not just with its 6- and 2-piece chicken nugget selections but also with its 2 $2 breakfast choices.
McDonald’s has a proven track record of excellent growth and is a dividend-growth company. The company might be among the finest investments given the recent performance of dividend payers over the past 12 to 18 months.
We believe that McDonald’s stock will eventually command a valuation of at least $300 per share, which is at the upper end of our fair value estimate range. As we shall discuss in this note, the company is well-positioned and operating efficiently, albeit we caution investors to be aware of its high net debt level and the fact that free cash flow was under pressure in 2022 following a very successful 2021.
At the top of our fair value estimate range, we value shares of McDonald’s at $306.
Away from Increasing Inflationary Pressures
Perhaps there are gaps in our understanding of McDonald’s business model.
By the end of 2022, the corporation will have more than 40,000 McDonald’s locations, although 95% of them will be franchised. Due to the fact that these fees are based on the sales at the franchisees’ own restaurants, they are quite lucrative and produce steady, dependable income (not profits).
To get a sense of how profitable its franchise revenue stream is in comparison to its company-owned restaurant revenue stream, let’s take a closer look at the data. For instance, in 2022, McDonald’s franchised locations brought in $14.1 billion in revenue, yet they only cost the company $2.3 billion to operate.
When compared to sales of its company-operated restaurants, where revenues totaled $8.7 billion and expenses totaled $7.4 billion, the margin on its franchised sales is significantly higher.
When we consider McDonald’s business model, its franchisees are really who we should be thinking of as its customers. These franchisees assume the operating risk of increased inflationary pressures, including those brought on by both growing wage costs and rising food prices. We prefer McDonald’s stock in an inflationary climate because of its primarily franchised business model, which helps protect it from these rising costs.
Exceptional Value Offered to Customers
Despite strains on consumer finances, McDonald’s comparable store sales have performed pretty well recently. For instance, global comparable sales increased by 12.6% in the fourth quarter of 2022, and more than 35% of the company’s systemwide sales are now made through digital channels (such as mobile apps, delivery, and kiosks).
In our opinion, the company’s mobile app is altering the game because the rewards may be significant. For instance, a user of the app can receive a free Big Mac for making their first delivery order, and they can also accrue Reward Points that can be redeemed for future purchases of additional food. For customers hoping to save a few dollars on each purchase, this may be a game-changer.
The app is succeeding because users might be able to acquire a complimentary Frappe or another item to lower their payment.
The affordability of its chicken nuggets is another important value proposition for customers. For instance, in Northern Illinois, a six-piece chicken nugget typically costs $2, while a 20-piece order can cost anywhere between $6 and $8. However, its $2/2 deals might be the finest offer. Getting a few sausage McMuffins for a few dollars is a significant savings considering how long it has been since one could get a deal like this.
Strong Growth and Dividend Track Record
McDonald’s is a leader in dividend growth. In October 2022, it last increased its dividend by 10% to $1.52 per quarter, translating to an expected 2.2% forward dividend yield. The company that makes the Big Mac began paying dividends in 1976 and has since increased it every year for 46 years. We don’t believe the executive team will take any actions to endanger the track record.
The free cash flow profile of McDonald’s has helped to fund its ongoing dividend growth.
Cash flow from operations totaled $7.4 billion in 2022, compared to capital expenditures of $1.9 billion. This resulted in a free cash flow of $5.49 billion, which was more than the $4.2 billion in cash dividends given during the same year. The company’s free cash flow is still very strong, despite the fact that expansion initiatives may result in higher capital spending in 2023, even if cash flow from operations has decreased from levels in 2021 due to reduced net income and working capital headwinds.
Although McDonald’s has a $35.9 billion long-term debt position, which is a lot but not fantastic, the company had investment-grade credit ratings.
Although Standard & Poor’s and Moody’s rate the company’s debt at BBB+ and Baa1, respectively, it may be argued that with its outstanding brand name and steady franchise revenue stream, McDonald’s is a stronger credit. It had $2.6 billion in cash and equivalents at the end of 2022. Although McDonald’s doesn’t perform well on our Dividend Cushion ratio, our sole financial measure of dividend health, the business’s fundamentals are as solid as those of any other company we track.
Due to its net debt position, McDonald’s has a poor dividend cushion ratio, but its free cash flow coverage of the dividend is still strong.
In the current market climate, McDonald’s is doing a lot of things right, treating customers and stockholders well with its discount menu selections and its proven track record of good dividend growth, respectively. This year, management anticipates opening a net additional 1,500 restaurants, and in 2023, we anticipate another dividend hike. Given its predominantly franchised business model, we believe the company is still protected from many of the inflationary pressures that are currently hitting restaurant owners. We believe the stock may be ideal for this type of market situation, even though McDonald’s free cash flow did experience pressure during 2022, larger growth spending should be anticipated in 2023, and the long-term debt burden is something to keep top of mind.
Featured Image: Freepik @ timolina