McDonald's (NYSE:MCD) has been an incredible growth story during the past decade. Earnings per share have more than tripled, dividends per share have increased by nearly a factor of six, and the company has become a dominant, highly profitable leader in the global restaurant business.
McDonald's has been an excellent stock for dividend investors, with the company raising its dividend every single year since its first dividend payment in 1976. From 2004 to 2013, its dividend rose at an annualized rate of about 21% and, along with a tripling of the stock price during that time, long-term investors have done very well.
But shares of McDonald's have been largely stagnant for the past few years, and recent dividend hikes have been much less impressive compared to years past. The most recent dividend increase was just 5%, for example, and investors may be rightfully concerned that McDonald's is beginning to lose its luster as a premier dividend stock. Does McDonald's still deserve a place in a dividend portfolio? Or is the fast food giant no longer a top dividend stock?
McDonald's has been having trouble in all of its major markets during the past two years. Here's a look at the company's recent comparable-store sales performance by region:
In the United States, comparable-store sales have been negative since the fourth quarter of 2013; in July and August of this year, things took a turn for the worse. Competition from companies like Chipotle is part of the problem, with consumers increasingly choosing higher-quality options, even at a higher price. Chipotle has enjoyed extraordinary success in recent years, and comparable-store sales rose by a staggering 17.3% in the second quarter on the back of price increases that its customers were more than willing to accept.
McDonald's has attempted to offer a wide variety of options, including healthier fare like wraps; but its growing menu has caused problems, with the company admitting that its menu had become overcomplicated earlier this year. Too many new items introduced too quickly can bog down the restaurants, leading to slow service and unhappy customers. The Mighty Wings debacle of 2013, where McDonald's attempted to sell chicken wings for $1 each, leading to 10 million pounds of unsold chicken wings, is a perfect example of McDonald's failing strategy.
In Asia, a recent scandal involving a meat supplier has caused McDonald's sales to plummet in the region. Asia represents a significant growth opportunity for McDonald's going forward, but it may take years to regain the trust of consumers. McDonald's has stated that the scandal would negatively affect its third-quarter earnings by as much as $0.20 per share.
Slower dividend growth
The current problems facing McDonald's are certainly fixable, and McDonald's still has a very strong brand and competitive advantages derived from its massive scale. However, once McDonald's fully recovers from the batch of issues facing the company, the dividend is unlikely to grow anywhere near as fast as it has in the past.
During the last decade, McDonald's dividend growth was driven by both a vast expansion of the operating margin, which rose from 18.6% in 2004 to 31.2% in 2013, and an increase in the payout ratio.
It's hard to imagine much more upside for the operating margin, and the payout ratio is likely about as high as the company will go. McDonald's spends around $3 billion per year on capital expenditures, opening new stores and remodeling old ones, and it's been a frequent buyer of its own shares; so raising the payout ratio further would require a reduction somewhere else.
Dividend growth going forward will likely be limited to earnings growth and, while the near term will certainly be challenging, mid-to-high single digit annual dividend growth seems like a realistic expectation, assuming that McDonald's does eventually fix its current problems.
With a nearly 3.7% dividend yield, thanks to the recent weakness in the stock price, this kind of dividend growth is still quite attractive. The yield is higher than it's been in years, and now looks like a great time to add McDonald's to a dividend portfolio.
McDonald's is facing serious challenges in all of its markets, and the short-term performance of the company will likely suffer as a result. But McDonald's will eventually fix these issues, and moderate dividend growth coupled with a very attractive yield make McDonald's a great dividend stock to own.
Timothy Green 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.
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