Dividend Report Card: McDonald's

In this series, we analyze financial metrics to begin answering the following questions about a company's dividend:

1. Over time, has this company steadily increased its payouts?
2. How sustainable is the dividend?
3. Does the company have room to further increase the dividend?

The Dividend Report Card wasn't designed as a buy or sell signal, but rather as a tool to gauge the health of a company's dividend. For a full explanation of each category, click here for a tutorial.

Today's pupil is McDonald's (NYSE: MCD), which posts a 3.2% dividend yield.

Dividend history

Source: McDonald's investor relations.

Over the past decade, McDonald's dividend policy shifted from one appropriate for a high-growth company to one befitting its mature blue-chip status. In 2008, for example, McDonald's switched from a single annual payment to quarterly payouts. It's increased its payout ratio from 14% in 2000 to about 49% today.

McDonald's has also paid a dividend each year since 1976 without a cut or suspension. For this category, it scores a 5 of 5.

Sustainability

Source: Capital IQ, a division of Standard & Poor's, as of March 14.

Even if we adjust for McDonald's off-balance sheet operating leases (common in the retail and restaurant industry), its interest coverage remains firmly in the top tier. Indeed, Morningstar gives McDonald's a very respectable "AA-" credit rating.

The dividend has also been consistently covered by earnings and free cash. Put simply, the current dividend appears very sustainable.

Growth

McDonald's spends a lot of its free cash repurchasing shares -- in 2010, for instance, it repurchased $2.7 billion worth of its stock and paid $2.4 billion in dividends. Fortunately for dividend investors, that ratio has improved since 2006, when it repurchased $3.9 billion in shares and paid out $1.8 billion in dividends. The company could conceivably pull back on less "sticky" stock repurchases and further fund dividends.

Analysts expect long-term earnings growth to be around 10%, and I would expect annualized dividend growth over the next five years to roughly approximate that rate.

Competitors
An "ungraded" section of the dividend report card compares a stock's current yield against that of direct competitors. If it's too high relative to competitors' yields, the board could be tempted to slow the growth rate, or cut the payout, to bring it more in line with the industry average.

With its current yield at 3.2%, McDonald's' dividend yield is a bit higher than this peer group, but its growth expectations are a bit lower, as well. Still, with its yield already well-above the S&P 500 average of 1.9%, the board may not be in a hurry to raise the payout at a double-digit rate unless the share price also rises.

Pencils down!
With all the numbers in, here's how McDonald's' dividend scored:

There's a lot to like about McDonald's besides its fries -- which, by the way, are still the best in the industry. With a dividend yield over 3% and the potential for at least high single-digit dividend growth over the next five years, it is definitely worth further research.

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