Here Are 3 Things to Consider Before Investing in McDonald’s

McDonald's may be at the precipice of a fundamental decline.

Jul 29, 2014 at 10:00AM

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Source: Motley Fool Flickr by William Bias

Investing legend Peter Lynch once said, "If you stay half-alert, you can pick the spectacular performers right from your place of business or out of the neighborhood shopping mall." 

With that said you may want to consider global restaurant chain McDonald's (NYSE:MCD). After all, its golden arches resonate across the globe with 35,683 stores in operation. However, you may want to research its fundamentals and consider what drives this company before making any investment decisions.

Declining traffic
Comparable-store sales represent a sales comparison between a group of established restaurants and retailers open for at least a year, generally speaking. This signifies an important measure in evaluating restaurants and retailers. It's pretty telling when customers begin to walk away from an establishment once the newness wears off.

Generally, underlying metrics such as guest count, price increases or decreases, and product mix, which is comprised of size and selection of product offerings, make up the comparable sales figure. Guest count represents a sales opportunity. Companies can't make a sale if no customers come through the doors.

As you can see in the table below, McDonald's experienced an uptick in comparable guest counts right after the recession ended in 2010. After that the company experienced a steady decline in guest traffic, and not surprisingly, comparable-store sales followed suit. Health-conscious consumers increasingly shy away from fast-food restaurants in favor of healthier and trendier fast-casual chains. 

 

2013 

2012 

2011 

2010 

2009 

Comparable Guest Count

(1.9%)

1.6%

3.7%

4.9%

1.4%

Comparable Store Sales

0.2%

3.1%

5.6%

5%

3.8%

The trend continues into 2014, with year-to-date comparable guest counts declining 3% and comparable sales increasing a mere 0.2% during that time. 

Heavy capital returns
In the table below you can see that over the past five years, McDonald's returned capital in excess of its free cash flow either in the form of dividends or share repurchases. However, from a tangible reward standpoint, McDonald's has leaned more toward dividends since 2011, with the company paying out 73% of its free cash flow in dividends versus 41% for share repurchases in 2013.

It's preferable that a company's dividend-to-free-cash-flow ratio lie below 50%. However, in this instance the ratio lies in the acceptable range considering the limited expansion potential due to McDonald's huge global presence. Currently McDonald's pays its shareholders $3.24 per share per year, which yields 3.2%.

 

2013

2012

2011

2010

2009 

Dividend to Free Cash Flow

72.5%

74%

59.1%

57.3%

58.9%

Stock Buybacks to Free Cash Flow

41.4%

66.8%

76.1%

64.2%

73.6%

Dividend + Stock Buybacks to Free Cash Flow

113.9%

140.7%

135.1%

121.4%

132.5%

Source: McDonald's Corporate Filings

Increasing long-term debt
McDonald's long-term debt increased 34% over the past five years. Its long-term debt-to-equity ratio climbed from 75% in 2009 to 88% in 2013, according to Morningstar. Capital returns in excess of free cash flow caused the company to find outside financing in an effort to achieve dividend payments and share buybacks. This isn't necessarily a concern at the moment but it is obviously unsustainable going forward. 

Looking ahead
The trend toward lower traffic gives cause for concern. However, McDonald's remains committed to returning capital to shareholders, as it should considering its limited expansion potential. However, expect dividends and share buybacks to come at the cost of a higher leveraged balance sheet.

Investors looking for long-term growth should look elsewhere as McDonald's reaches global saturation. Investors looking for income from dividends may want to consider McDonald's. However, McDonald's needs get customers back in the door, or its dividend may be compromised over the long term.

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William Bias owns shares of McDonald's. The Motley Fool recommends McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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