McDonald's (NYSE:MCD) is a popular dividend stock. The fast-food giant has a solid track record of dividend growth over time, and the payout's 3.6% yield looks quite attractive for a big and stable company generating tons of cash flow. On the other hand, sales have stagnated lately, and this puts downward pressure on dividend growth prospects.
Let´s look at two important aspects of McDonald's that dividend stock investors need to keep in mind when considering a position in the company.
McDividends are safe and sustainable
McDonald's started paying dividends in 1976, and the company has raised them every year since then, including a 5% increase announced on Sept. 18. It takes a solid and reliable business to raise dividends over 38 consecutive years.
McDonald's shareholders have been deliciously rewarded as the company expanded its restaurant base around the world through the decades. The company had more than 35,000 restaurants in 119 countries as of the second quarter of 2014.
Size can be a considerable advantage for competitive strength and financial soundness. The company's scale allows McDonald's to obtain convenient prices and conditions from suppliers, which it translates into competitively low prices for many of its offerings. Geographic location is an important competitive factor in the business, and McDonald's has positioned its restaurants in many of the most coveted and transited corners around the planet.
Since McDonald's operates more than 80% of its stores under the franchise model, the business generates solid profit margins and consistent cash flow through good times and bad. Even as the company is generating a lackluster financial performance lately, it is producing more than enough cash to finance dividend payments.
During the first six months of the year, McDonald's generated $3.4 billion in cash flow from operations; the company invested $1.2 billion in capital expenditures, leaving $2.2 billion in free cash flow. Dividend payments required only $1.6 billion during the period, showing that McDonald's is comfortably able to cover those payouts.
No more supersized dividend growth
On the other hand, dividend growth has materially slowed in recent years, probably due to stagnant sales growth. Even if the business is generating sufficient cash flow, management is taking the safe road by keeping dividend growth at moderate levels.
Consumers today are paying more attention to the health implications of the food and drinks they consume, and McDonald's is clearly on the wrong side of that trend. The company is trying to accelerate growth via product innovation and more sophisticated menu offerings, but this is not generating the desired results so far. Making matters worse, service quality and speed have suffered due to increased complexity in the menu, so McDonald´s has gone from bad to worse lately.
While most traditional fast-food chains are also facing considerable headwinds, fast-casual player Chipotle Mexican Grill (NYSE:CMG) is generating explosive growth rates and proving that customers will pay a few extra dollars for higher-quality food made with fresher ingredients and superior ecological and sustainability standards.
Chipotle seems to be attracting many of the consumers who are losing their appetite for Big Macs: The company has delivered a truly explosive growth rate of 19.3% annually through the last five years. In the last quarter, sales grew at a spicy 28.6% on the back of a 17.3% increase in comparable sales.
With only 1,681 restaurants, Chipotle is considerably smaller than McDonald's, so the comparison is not entirely fair. However, the performance gap between the two companies is quite astonishing: McDonald's recently announced that global comparable sales declined 3.7% in August, while comparable sales in the U.S. fell 2.8%.
Until McDonald's finds a viable strategy to reverse the decline in sales, dividend growth will most likely remain subdued. After all, growing dividends need to be financed with increasing sales and cash flow in the long term, and McDonald's seems to be really stuck in that department.
McDonald's pays a generous dividend yield, and those payments are certainly sustainable in the medium term. However, stagnant sales are a serious drawback for investors in the fast-food giant, since dividend growth will remain under pressure until sales rise.
Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill and McDonald's. The Motley Fool owns shares of Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.