Should You Buy McDonald's After A So-So Year?

Karen Canella's picture

Thursday, January 16, 2014 - 8:30am

by Karen Canella

This just in: The Department of Agriculture warns that record droughts in Texas and the Midwest may drop beef production to 20-year lows in 2014.

I can just see the writing on the wall over the next few days about how you should steer clear of McDonald's (NYSE: MCD), that higher costs to the burger empire will strangle its already tight margins.

Expect analysts to dwell on its mere 2.5% growth in profits last year and MCD's 4% gain on the year -- pathetic in the context of a record bull run. 

Analysts may focus on McDonald's' struggles in China and Europe or the absence of restaurants in a number of emerging markets. Some could even bring up past menu disasters like the McDLT, McLean Deluxe, McSalad Shakers and McLobster... and the recent switch from Heinz ketchup.

But my argument for investing in McDonald's is based on one simple trait that the Big Mac maker shares with Big Pharma and Big Tobacco -- but has nothing to do with food, drugs or cigarettes.

They're all experts at converting revenue into cash -- and regularly divvying up portions to shareholders. 

Between 2008 and the third quarter of last year, McDonald's converted 16% of its revenue into free cash flow. Compare this with Philip Morris (NYSE: PM) at 29.1%, Pfizer (NYSE: PFE) at 26.4%, and Johnson & Johnson (NYSE: JNJ) at 20.2%.

McDonald's is particularly good at spreading its wealth.

Millions And Millions Of Shares Repurchased​

During that five-year period, MCD rewarded investors with a 116% increase in dividends. In fact, McDonald's has paid them every year since 1976 so that streak is not likely to come to a screeching halt anytime soon. In 2011 and 2012, the company repurchased shares worth $2.6 billion and $3.4 billion, respectively.

   
  Flickr/dave_mcmt  
  Between 2008 and the third quarter of last year, McDonald's rewarded investors with a 116% increase in dividends. In fact, McDonald's has paid them every year since 1976 so that streak is not likely to end anytime soon.  

At the end of its fiscal third quarter, the fast food giant increased its dividend 5% to an annualized $3.24 a share. Shareholders can expect a return of $4.5 billion to $5 billion this year through a combination of dividends and share repurchases.

When companies buy back their outstanding shares, the remaining outstanding shares become worth more because there are fewer of them. For the most part, companies do this to reward shareholders and increase loyalty. 

Buybacks, however, don't necessarily translate to healthy finances. They can also be a cover-up for lack of earnings and funded entirely by debt.

That's clearly not the case with McDonald's. Of the $7.3 billion generated in the past four quarters, 55% is earmarked for reinvestment in growth; and shareholders grabbed the remaining 45% or $4 billion. Like I said, the company is looking to be equally generous in 2014 thanks to an expected 8.6% increase in the bottom line. Plans are underway to build as many as 1,600 additional restaurants and remodel another thousand.

Despite the calories and fat, I like McDonald's fries and burgers -- and I'd expect the 65 million other customers it serves do, too.

I also like the way it stands up to adversity, shrugging off earnings misses, skimpy stock appreciation, and criticisms about low wages and corny marketing. Plus, nearly 65% of shares of MCD are owned by institutions, a testament to the company's strength.

Most of all, I like how McDonald's is committed to serving its shareholders.

Risks to Consider: Should the current trend of rising beef costs persist, that certainly could cut into profits. However, I don't see it as a threat to McDonald's long-term stability or its ability to keep increasing dividends. 

Action to Take --> MCD has dropped about 10% since April, so I'd buy on the weakness at $95. Remember, this isn't a stock that will have sharp movements up or down. Buy it for the long term -- and the profits and dividends.

P.S. With its history of dominating its industry and rewarding its shareholders, it's no surprise McDonald's was recently named one of the Top 10 blue-chip stocks by the StreetAuthority research team. We recently identified more of the market's most dominant companies in a recent report, "The Top 10 Stocks For 2014." These 10 stocks have delivered a market-crushing total return of 237% over the past five years, including individual gains of as much as 925%. To get more information, including names and ticker symbols, click here.

Karen Canella does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.