Dividend Stock Wednesday: McDonald’s Corp (MCD)

Note: I use the Stock Selection Guide Software and its methodologies from the CSA to perform the bulk of my analysis on stocks.

Company Profile:

McDonald’s Corporation operates as a foodservice retailer worldwide. It operates and franchises McDonald’s restaurants, which offer various food items, and soft drinks and other beverages.

Revenue Profile and Projection:

Let’s start by examining management’s ability to convert the companies products and services into increased sales on a consistent basis, year after year. To pass the revenue test, the company must possess the following two attributes:

1. a steady and consistent revenue uptrend
2. the ability to continue to grow revenues in the future, giving consideration to such things as demographics and market trends (i.e. the move from film to digital)

The revenue profile:

The revenue profile for MCD is presented below. Based on a visual analysis of this trend, the trend is up – not steep or exceptionally fast – but up.

Revenue projections:

Being conservative, but not too conservative, a revenue growth rate must be extrapolated to project a revenue number 5 years from now. This will not be an exact science but will provide us with a projection of what revenues you can expect the company to generate in the future. This is important because it is revenues that lead to earnings. One important thing to consider is whether revenue growth is accelerating or decelerating – this helps make a judgment call on what growth rate to apply.

Historical Growth Rates:

McDonald’s revenue growth rate has been very stable over the past 10 years, which I like to see. The highest period of growth for the company in in this period was years 1 to 5 at 8.4%. Of slight concern is the reduced revenue growth rate over the past 2 years, which is in fact the lowest growth rate of the periods presented. This will need to be monitored closely over the next year.

I have also taken a look at Value Line’s revenue growth projections for MCD – they are projecting that MCD will grow revenues at a rate of 6.5% for the next 5 years. This is consistent with the data we see above. I have chosen a conservative revenue growth rate of 6.4% which would mean, at the end of 2011 the revenue for MCD will be approximately $29,437 million per year.

EPS Profile and Projection:

I want to now move onto looking at the company’s earnings per share – how well the company turns those revenues into earnings for shareholders. To pass the EPS test, the company must possess the following two attributes:

1. a steady and consistent EPS uptrend
2. the ability to continue to grow EPS in the future

The EPS profile:

The EPS profile for MCD is presented below. This is not the best picture of earnings that I have seen – not by a long shot. In fact, the earnings appears to be very choppy, especially from 2000 – 2003. The saving grace is that the company has substantially improved performance over the past few years and has seen some very good earnings growth.

EPS projections:

Just as with the revenue projections, being conservative, but not too conservative, a EPS growth rate must be extrapolated to project a revenue number 5 years from now. This will not be an exact science but will provide us with a projection of what EPS you can expect the company to generate in the future. Again it is important to consider whether EPS growth is accelerating or decelerating – this helps make a judgment call on what growth rate to apply.

Historical Growth Rates:

Once again, we see that earnings have been a bit erratic over the past 10 years. Although it has been high at 10% over the past 2 years, it has slowed down from the 2002 – 2005 period. This will need to be taken into account when I start to price the stock.

I again went to Value Line for some additional data and see that they have projected an earnings growth rate over the next 5 years of 9.5%. I am not sure how they can estimate earnings to grow faster than revenue, so I want to be more conservative on this. I have chosen to apply a growth rate estimate of 6.7% to more accurately represent the prior 10 year growth rate. At the end of 2011 the EPS for MCD will be approximately $3.25 per year. The current year estimate is $2.51, which is a bit lower than the analyst consensus of $2.81.

Dividend History:

As a dividend investor, I of course look at dividends. Usually, I already know at this point that the company at least pays a dividend and has a strong history of increasing their dividend payouts on a consistent basis. The only analysis I do on dividends at this point is to quickly look at the dividend history over time. I want to see at least 10 years of uninterrupted and growing dividend payments to shareholders. Here is McDonald’s dividend chart:

That is a serious up trend starting at 2002. I would prefer to see a more steady trend rather than a hockey stick like this, but it is good to see. I would suspect that this intense growth will even out over the next 5 years. It won’t stop, but it won’t go up as fast (IMHO).

Share Price Valuation:

I use 2 methods to compare a company’s share price. The first is looking at the dividend yield to see how the current yield compares to the 10 year average yield for the company. The second is determining a buy range for the stock through the analysis of the recent price for $1 of EPS in relation to historical prices. Here is my results of my valuation.

Dividend Yield

Current Dividend Yield: 2.63%
Average Dividend Yield for past 10 Years: 1.40%
Is the current dividend yield higher than the average dividend yield for past 10 years:Yes

With an average dividend yield over the past 10 years of only 1.4%, the current yield of 2.63% makes the stock feel like a real buy. I don’t want to jump to conclusions yet, but this is a good sign. It can partially be explained by the extreme dividend growth rate over the past few years that is pushing the yield up.

Buy Range

Recent Price (how is the current price sitting in relation to historical averages):

EPS Projected Growth Rate: 6.7%
Recent P/E ratio: 22.4 (= current stock price dividend by current year projected EPS of $3.73)
Relative P/E ratio: 1.11 (= recent P/E divided by 10 year average P/E)

Based on a relative P/E of 1.11, buying the company today would indicate that we are buying at a premium of 11% compares to the 10 year historical P/E values. I like to see this at no more that 5 – 10% premium.

Upside Price (based on the EPS projection, what price might we expect if the growth continues on the trend we saw in our analysis of revenue and EPS):

Upside price: $79.95 (= upside EPS in 5 years X upside P/E ratio in 5 years)
Upside P/E ratio: 24.6 (= 10 year average high P/E ratio)

Downside Price (based on the EPS projection, what price might we expect if the growth continues on the trend we saw in our analysis of revenue and EPS):

Downside price: $45.62 (= current price – (1 – 20% decline))

Buy Range

The buy range for MCD is $45.62 to $57.06

This is calculated by:

(Upside Price minus – Downside Price) divided by 3 = $11.44 which is the size of the buying zones I use (buy/wait/sell). The buy zone is simply the downside price plus the zone size.

Summary

Based on MCD’s current price of $56.96, my analysis calls this stock a buy (not by much). I am very encourage by MCD’s recent focus on dividend and earnings growth. If they can continue to perform well in the coming years, then I think there will be good things to come from them. There is the risk of healthy eating, but I am encouraged by the steps the company to provide healthy alternatives. (sandwiches, etc).

Disclosure: The Dividend Guy does not own shares in MCD. This is my analysis of the stock and is not investment advice. Do your own research.