Many investors believe Yum! Brands is the best China play that isn't a Chinese company.
As the company behind KFC, Pizza Hut, and Taco Bell, it's certainly a compelling shot at long-term gains for investors who want some Chinese exposure.
But we think there is one other fast-food giant that offers the same chance to cash in on the growth of the Chinese consumer, but with a bit more safety. That's because McDonald's [NYSE: MCD] comes with an attractive dividend yield, as well as a handful of less-obvious catalysts.
Let me explain.
McDonald's operational performance is top notch. That's why it's been able to pay and increase dividends for decades. The restaurant titan just upped its dividend, making for an annual $3.08 per share -- or 3.3% -- more than double the amount it paid out five years ago.
Of course, historical dividend growth doesn't mean much unless you owned the stock over that period. You also need to consider how your company might increase its payouts in the future.
So consider the following table:
|Company||Dividend Yield||5-Year Dividend Growth Rate|
|Procter & Gamble||3.2%||10%|
While McDonald's and Procter & Gamble offer lower yields, their strong consumer franchises give them much greater ability than the other two to raise their dividends over time.
On the other hand, both Frontier and Annaly are less able to sustainably deliver dividend growth. While their yields are both sizable, the prospects for future gains are limited.
Frontier operates in the declining fixed-line telecom space, and has cut its payout as it integrates some rural operations recently acquired from Verizon. Meanwhile, Annaly increased its yield because its net interest margin increased as interest rates dredged the bottom.
While Annaly is a nice play in disinflationary times, interest rates won't remain low forever, and when they rise, its dividend will likely take a hit.
Of course these criticisms don't mean either company isn't worth owning. But it is a reminder that you need to understand the sustainability of your dividends. Blending high payouts with high dividend growers could make a lot of sense.
McDonald's occupies something of a middle ground, and its recent massive increase in its dividend payout is just the beginning. There are good signs that the company has plenty more in store.
McDonald's has indicated that for the future it intends to pay out all its free cash flow. Some of that cash will go to repurchase shares. In September 2009, McDonald's authorized a $10 billion repurchase plan, and the company wasted no time in snapping up shares. It has been buying back billions of dollars worth of its shares.
But the rest of that cash seems earmarked for dividend increases, which could be significant.
McDonald's has at least two other potential opportunities to unlock cash.
First, the company is selling its company-operated stores to franchisors. Right now it operates only about one-fifth of its locations. It's great to see this number continue to come down, because McDonald's realizes a better-than-80% margin on franchised stores. On the other hand, its company-operated stores have less than a 20% operating margin. So by refranchising more stores, McDonald's will increase its margins and free capital tied up in its stores, giving it even more opportunity to raise its dividend.
The second hidden store of value is in McDonald's real estate holdings. Even as the company sells off franchises, it maintains the rights to most of its land and buildings. Some of that real estate is in prime locations and has been sitting on the company's books at cost for decades.
The mechanism that Mickey D's might use to unlock that value is unclear, but the value is there. And since CEO Jim Skinner is pulling out all the stops to make the company a more efficient user of capital, you can expect him to figure out a way to return this value to shareholders.
A quick dividend discount valuation suggests that McDonald's is about fairly valued..
But given the company's willingness to return all its free cash flow, I'm willing to bet that McDonald's can achieve -- and likely exceed -- these goals.
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