Please ensure Javascript is enabled for purposes of website accessibility

Why McDonald's Dividend Is Safer Than It Looks

By Demitri Kalogeropoulos - Jul 6, 2016 at 11:03AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The fast food chain's 40-year streak of dividend raises isn't about to end any time soon.

Income investors haven't had much to cheer regarding McDonald's (MCD 0.83%) dividend lately. The pace of payout hikes has slowed over the last few years, dropping from a double-digit percentage raise to only 5% now.

Meanwhile, dividends are taking up a larger portion of earnings, which limits management's flexibility to announce big raises. In 2015, McDonald's dividend soaked up $3.2 billion, or just over 70% of profit. The payout ratio was 50% as recently as 2013.

The fast-food giant's dividend isn't in danger of a cut or a pause, though. In fact, it's well covered by cash flow and by McDonald's financing initiatives. An encouraging rebound in operations also suggests heftier hikes could be on the way.

McDonald's dividend history

McDonald's has paid -- and boosted -- its dividend for 40 consecutive years. That's long enough to put the restaurant operator in an exclusive group of just 50 companies, called Dividend Aristocrats, who boast a streak of at least 25 years of annual raises.

Metric

2015

2014

2013

2012

2011

2010

Dividend Raise

5%

5%

9%

13%

12%

10%

Payout Ratio

72%

68%

56%

54%

48%

49%

Data source: Company financial filings. 

The last five years have brought slowing growth that's tied to McDonald's declining earnings. Net income dropped 20% between 2013 and 2015. The company continued to boost its payout in those years, although at a reduced pace. Put those two trends together, and you get a payout ratio that's surged from the traditional 50% level to over 70% last year.

Why the stock dividend could rise

Operating trends are looking better so far in 2016. McDonald's recently posted a 6% jump in comparable-store sales (verses a 2% drop in the year-ago period) on the strength of an all-day breakfast initiative that's helping boost customer traffic levels in the United States. Its overseas markets, especially China, Russia, and Japan, are also enjoying a solid rebound.

McDonald's refranchising plan, whereby it sells company-operated restaurants to franchisees, is boosting financial results as well. The company now controls just 19% of its global store base and plans to get that number down to just 5% by the end of 2018. While the move puts pressure on sales growth, it also results in steadier, more predictable revenue and cash flow as dining sales are replaced with franchisee fees and rent. Investors can see evidence of this shift in the company's profitability, which has climbed back up toward 30% of sales from 26% last year.

MCD Operating Margin (TTM) Chart

MCD Operating Margin (TTM) data by YCharts.

McDonald's strong cash flow is the best reason to believe its dividend has a long future of raises ahead. Last quarter, the company generated $1.7 billion of cash, which exceeded its business needs by $1.3 billion. Its dividend payment, meanwhile, amounted to less than $800 million. In other words, the business produces ample excess cash that management can direct back toward shareholders.

For the moment, the company favors sending that cash back through the share buyback channel. Last quarter, it spent $3.7 billion on its own stock compared to its less than $1 billion dividend payout.

Image source: McDonald's.

That focus should shift back toward dividends as earnings rise high enough to provide more flexibility to CEO Easterbrook and his executive team. McDonald's payout ratio is already headed back down, falling to 66% -- down from 72% at the start of the year. If that trend continues over the next few quarters, shareholders may see a more substantial dividend boost for 2017 than the low single-digit range they've endured since 2014.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

McDonald's Corporation Stock Quote
McDonald's Corporation
MCD
$235.84 (0.83%) $1.93

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
330%
 
S&P 500 Returns
115%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/23/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.