The market is picking up steam in 2023 as investors gain more confidence in the economy's potential to improve this year. Some stocks have already doubled in value only one month into the new year, and others are clawing their way back more slowly.
McDonald's (MCD -0.05%) stock was roughly flat in 2022, outperforming the broader market, and it remained so straight through January. It certainly seems like the investing community isn't sure how to price McDonald's right now, giving it a clear hold, despite its increasing sales, blue-chip status, and decades of dividend growth.
Let's try to figure out why, and whether or not your should place an order.
Ending the year with a bang
MdConald's comparable sales (comps) increased 12% year over year in the 2022 fourth quarter although consolidated sales decreased 1%. These results factored in the ceasing of the company's operations in Russia as well as closures in China, and they beat Wall Street's estimates.
In the U.S., strong comps were fueled by strategic price hikes as well as McDonald's' robust delivery network. Globally, more people visited McDonald's restaurants as inflation made it more attractive to get cheap takeout.
Since McDonald's operates a franchise model -- 93% of McDonald's stores are franchised -- its recorded revenue doesn't include sales from franchises, but rather franchise fees. Systemwide sales include all sales from franchises and so do comps. The franchise model, which leaves restaurant operations to franchisees, leads to very strong margins for the company.
MCD Gross Profit Margin (Annual) data by YCharts
Pressure in store for 2023
Management warned of a slowdown in 2023 as costs continue to rise and diners spend less. It anticipates pressured margins as it cycles through what it feels is short-term pressure. It's still guiding for a free cash flow conversion rate of at least 90%, meaning it expects to convert that much of its net income into free cash flow.
The company launched a plan last month to revitalize itself, furthering its Accelerating the Arches strategy, which has three objectives: maximize marketing, commitment core products, and the four "d"s -- digital, drive-thru, delivery, and store development.
As large as McDonald's is with 39,000 locations, it's actually stepping up its store opening strategy. It's planning to open 1,900 new stores in 2023, with 400 of them in the U.S., where it currently has nearly 13,500.
It's more than just the brand
McDonald's has unbeatable name recognition, and that plays a big role in generating higher sales. But newer investors may not realize that McDonald's sales were actually slipping prior to the pandemic. The brand wasn't enough to increase sales when the company itself needed an overhaul. Despite the declines, though, net income has been fairly steady, meaning the company is good at turning sales into net income.
Today, quarterly sales are almost exactly at the average, while net income is soundly above it.
MCD Net Income (Quarterly) data by YCharts
Management has done an excellent job of maintaining robust profitability, especially in this inflationary environment.
The dividend is the best part
With its strong profitability and free cash flow, McDonald's gives back to its shareholders in two ways. First, it has a significant share buyback program, which makes each share worth more. It also pays a growing and reliable dividend. It's not the highest yield you can get, but it's higher than average at 2.2%, and it has been increasing for the past 46 years.
Investors should expect more of the same from McDonald's this year and into the future, which is a focus on cash generation and shareholder wealth creation. The new direction toward store development could be key to a revitalized brand and unlocking future value from the brand.
Ultimately, McDonald's is a solid dividend stock that should provide years of passive income for investors.
