After the market closed on May 28, 2014, McDonald's (NYSE:MCD) CEO Don Thompson announced that the management team had decided to make some big changes to the fast-food giant. One of the company's biggest plans is to increase its cash return to shareholders over the next three years.
At first glance, this may seem like great news, but there are some concerns that shareholders in the company should have moving forward. Chief among these is that the business is focusing on giving back to shareholders when it could focus its efforts on growth initiatives, like buying rival Chipotle Mexican Grill (NYSE:CMG), instead.
McDonald's has had phenomenal results... until recently!
Over the past five years, McDonald's has done pretty well for itself. Between 2009 and 2013, the business has seen its revenue climb 24% from $22.7 billion to $28.1 billion. For the most part, the company's growth was driven by an aggregate 19% improvement in comparable-store sales but was also positively affected by an 11% rise in store count from 31,967 locations to 35,429.
From a profitability perspective, the company also did well but not quite as well. During this five-year period, McDonald's reported a 23% rise in net income from $4.6 billion to $5.6 billion, as higher sales were offset by just marginally higher costs. Even more impressive has been the company's return on equity, which inched up from 32.4% to 34.9%.
In an effort to reward shareholders, McDonald's has decided that it might be best to return as much cash as it can to its investors. In just the past three years, management has paid out about $8.6 billion in the form of dividends and has repurchased $7.8 billion worth of stock that it holds on its balance sheet as treasury shares. Over the next three years, the company wants to increase its cash outlays to investors from an aggregate $16.4 billion to between $18 billion and $20 billion.
While this may seem like a good idea, the restaurant king might want to reconsider this course of action. Yes, dividends and buybacks are good ways to give value back to investors, but a more efficient way given the company's profitability might be to invest that money in growth. In just the past year alone, McDonald's saw its comparable-store sales growth grind to a halt, falling from 3.1% in 2012 to 0.2% in 2013, so management might serve all stakeholders better by allocating more of its resources to initiatives geared toward combating slow growth.
Is this the perfect opportunity for McDonald's?
One way to accomplish this would be to acquire Chipotle. In its early days, the fast-casual chain was majority-owned by McDonald's, but through an IPO the company divested itself of the business completely and in the process pocketed $1.5 billion. Since then, however, the gourmet burrito operation has seen its market cap soar to almost $17 billion and its net income hit $3.2 billion, 112% higher than the $1.5 billion management reported five years earlier.
Although an acquisition of Chipotle would probably cost $20 billion or more, McDonald's has treasury stock built up from its buybacks that would be worth, today, about $67.7 billion. Not only would this make a deal possible, it would allow the business to reassimilate the company without assuming any debt.
Based on the success McDonald's has experienced over the long run, it makes sense that management would like to reward its shareholders by maximizing their returns through buybacks and dividends. However, the business should take a look at reinvesting its capital in a way that would likely generate higher sales and profits in the years to come. By distributing capital, the company is creating short-term value today, but by acquiring a productive asset like Chipotle or through experimenting with new concepts, the business would have the ability to set itself and its investors up for more money down the road.