The McDonald’s share is considered a lucrative dividend payer and is popular with investors. The share price has been rising for decades (!) And has literally skyrocketed in recent years. The price of the share more than doubled between 2015 and 2019. This is thanks to a change in McDonald’s business strategy, with which the company has increased its profitability enormously. This strategy was very well received on the stock exchange, which can be seen in the development of the share price. This analysis shows how McDonald’s managed this feat and whether you, as a shareholder, could also benefit from it.
|Market capitalization||€ 125.8 billion|
|Stability dividend||1.0 of max. 1.0|
|Stability gain||0.97 of max. 1.0|
The business model: How McDonald’s makes money
The original McDonald’s business model should be known to almost everyone. Founded in 1940 as a Hamburg stand, the prototype of today’s franchise grew out of it. The restaurants have spread quickly and can now be found in almost every country in the world. Today there are 38,000 restaurants that serve almost 70 million customers in just one day. This makes McDonald’s the second largest restaurant chain by number of branches worldwide. Starbucks only has even more locations with 42,000 branches.
McDonald’s earns its money from the income in its own restaurants and from license payments from the franchisees. Almost everyone knows that McDonald’s is a franchise. Until recently, however, a good proportion of the restaurants were owned by the company. That has changed a lot in recent years. In 2015, McDonald’s presented a plan for a new corporate strategy. At that time, about 80 percent of restaurants were owned by franchisees. The new strategy envisaged increasing this proportion to 95 percent. This plan is now well advanced. At the end of 2019, 93 percent of McDonald’s restaurants were licensed. The goal of 95 percent is thus almost achieved. This strategy has increased McDonald’s profitability tremendously and is probably one of the main reasons for the rapid rise in the share price. In the chart you can see how the price of the share developed over the period of the strategy implementation.
That’s why McDonald’s is so profitable
For decades, McDonald’s has increased earnings per share without major setbacks. The chart shows the steady increase in earnings and cash flows per share. You can also see the dividend history, which was increased every year without exception. It is nice to see that the dividend was always financed sustainably from the profit increase.
McDonald’s was a very profitable company even before the corporate strategy was adjusted. Thanks to the standardized menus of the restaurants, the supply chains are very efficient. Marketing expenses are also particularly effective. The uniform product range combined with high purchase numbers also reduces the material costs enormously. This in turn ensures high margins. Due to the low costs, McDonald’s can still offer its customers the products at low prices and at the same time make high profits for themselves.
If you look at the development of sales, you will surely notice the negative trend in recent years. This is due to the one already mentioned new corporate strategy. In 2015, McDonald’s began converting a majority of the remaining company owned restaurants into franchises. The loss of revenue comes about because the restaurant revenue is no longer counted as McDonald’s revenue. Instead, the company generates its revenue from the license fees that franchisees pay to McDonald’s. However, this also eliminates the cost of operating the restaurants. McDonald’s also has to invest less because it no longer has to maintain the restaurants themselves. The strategy lost sales once. But McDonald’s has become a much more profitable company. The strategy increased the operating margin from just under 29% in 2015 to over 41% in the meantime. The license fees are a stable source of income without McDonald’s having to take care of the restaurants longer than owners.
Is the dividend safe?
Since McDonald’s first paid a dividend in 1976, the payout has increased every year without exception. So McDonald’s has not only paid a dividend continuously for 44 years, but has also increased it 44 years in a row. In the past 10 years alone, the dividend has more than doubled, which corresponds to growth of 8.53 percent annually. With this, McDonald’s got its name as a dividend aristocrat more than deserved. This is the name of a company that has continuously increased its dividend for 25 years.
As is common for companies in the United States, McDonald’s pays its dividend quarterly. The next payment this year is expected to take place in mid-June. Shareholders are currently receiving $ 1.25, which corresponds to approximately € 1.14. McDonald’s always starts dividend increases with the last quarterly payment of the year. The increased amount is then also the amount for the first 3 quarters of the following year. It is estimated that McDonald’s shareholders will receive more than $ 5 for the first time this year. Assuming $ 1.35 (estimate) for the last dividend this year, the figure is $ 5.10, which would be a dividend yield of 2.8 percent. The return is in the middle of most companies. There are other solid dividend payers with a higher yield of 3-4 percent. However, there are also companies like Apple, which can only show a dividend yield of 1 percent as a result of its enormous price increase.
The level of debt is very important for the security of the dividend. McDonald’s debt has increased rapidly in recent years. More specifically, it has doubled in the past 5 years. The main reason for this are Share buybacks. Buying back shares is a popular instrument for companies to let profits flow to shareholders in a tax-efficient manner. McDonald’s uses this instrument very aggressively. From 2015 to 2019, the company spent a total of $ 32 billion on share buybacks. If you look at the increase in this period in the debt graph below, you will notice that this is roughly equal to the amount of the increase in this period. The rising debts are the bars in red. The value of the repurchased shares is shown in yellow.
Perhaps you are now wondering whether share buybacks financed by borrowing are sustainable. Potential doubts are in fact not unjustified. In principle, a company cannot borrow indefinitely to buy back shares. This would also mean that the shareholders would gain nothing because the money for the buybacks, including the interest, would have to be repaid at some point. At McDonald’s, the buybacks have a tactical background in addition to a direct shareholder satisfaction with a larger share of the company per share. To take a digression into finance: Equity is much more expensive than debt for companies like McDonald’s. With the share buybacks, McDonald’s has gradually replaced expensive equity with cheaper debt. Although this increases debt, it lowers the cost of capital. However, higher debt also means a higher risk. However, since McDonald’s is generating stable returns, the risk of the debt burden becoming imbalanced is diminishing. Basically, I don’t think the aggressive buyback of own shares is problematic. This tactic makes sense, especially when interest rates are historically low. McDonald’s also does not have to worry about not being able to service the interest on the debt. The operating profit was more than 7 times the interest burden in 2019.
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