McDonald’s Corporation (MCD) needs no introduction. It’s fairly safe to say that most people have had a meal in one of the company’s restaurants at least once in their lifetimes. McDonald’s operates in 119 countries, with 39,676 of its 36,986 restaurants franchised, representing 93% of McDonald’s total restaurants.
This is the magic of McDonald’s business model, as the company makes most of its money off of the real estate rents and royalties its franchisees pay, without having to undergo the hassle involved in actually operating its locations.
In my view, McDonald’s is a reliable investment likely to keep producing positive shareholder returns for years to come. That said, the stock’s valuation has now been expanded significantly higher from its historical average levels, which could be rather worrying. I am neutral on the stock.
Latest Results
McDonald’s Q3-2021 results were very strong, with the company recording revenues of $6.20 billion, 14% higher year-over-year. Revenue growth was driven by strong performance in both company-operated restaurants and franchised restaurants.
Net income came in at $2.15 billion or $2.86 per share vs. $1.76 billion or $2.35 per share in the comparable period last year, powered by higher margins from the company’s franchised restaurants. Adjusted EPS was $2.76 compared to $2.22 previously as well.
Based on McDonald’s adjusted EPS of $7.05 during the first nine months of the year, I expect the company to deliver full-year adjusted EPS of around $9.40.
Dividends and Valuation
McDonald’s also boasts the title of Dividend Aristocrat, with its dividends having grown annually for the past 45 years without any interruptions. In September, McDonald’s hiked its dividend once again, as it has done continuously since 1976. The increase was by 7%, which is great news since McDonald’s previous DPS hike was by 3%, and it was the softest DPS increase since 2002. Hence, this implies strong dividend growth pace acceleration.
Based on a potential FY2021 adjusted EPS of $9.40, the company’s P/E stands at around 28.5. On a forward basis, the P/E stands at 26.8 due to the earnings growth expected next year. However, note that this is a significantly higher multiple from its past decade-long range of around 18-22. Hence, the possibility for valuation compression in the medium term is not unlikely.
This is also illustrated in the stock’s dividend yield, which currently stands at 1.95% and is certainly below its historical average levels. Hence, for current investors, McDonald’s capital returns are notably softer versus the previous years, further reducing their margin of safety under a potential valuation compression scenario.
Wall Street’s Take
Turning to Wall Street, McDonald’s has a Strong Buy consensus rating, based on 22 Buys and four Holds assigned in the past three months. At $281.56, the MCD stock forecasts imply 5.4% upside potential.
Conclusion
McDonald’s has been a reliable investment, especially for dividend-growth and income-oriented investors. The company’s operating structure and brand value remain robust. That said, amid an expanded valuation following the stock’s extended rally over the past year, I would not allocate capital on the stock for the time being.
Disclosure: At the time of publication, Nikolaos Sismanis did not have a position in any of the securities mentioned in this article.
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