McDonald’s Stock Analysis – Is the Golden Age of the Golden Arches Behind us?

McDonald’s Corp (MCD) franchises and operates McDonald’s restaurants in the food service industry. Its geographic segments include the United States, Europe, Asia-Pacific, the Middle East and Africa.stock report

-Seven Year Revenue Growth Rate: 3.47%
-Seven Year EPS Growth Rate: 7.19%
-Seven Year Dividend Growth Rate: 18.49%
-Current Dividend Yield: 3.52%
-Balance Sheet Strength: Strong

 

Overview

Mickey D doesn’t need an introduction anymore. It’s the largest fast food retailer with over 36,000 restaurants servicing over 69 million clients throughout 100 countries every day. It was one of the very few stocks to practically ignore the 2008 recession and continue to reward investors. However, the stock is now lagging the market since mid-2014. This is what caught my attention and led me to take a look at one of the most famous aristocrat stocks.

MCD aristocrat

Source: Ychart

 

Business Segments

The company doesn’t offer 100 different products as you can eat the very same Big Mac in London UK that you would in Tokyo. However, management has divided its business according its geographic segments:

US

MCD shows decreasing sales of -1.7% in US for 2014 due to negative growth in guest traffic. In other words, the golden arch doesn’t serve as many clients as before. Competition is very tough and with MCD’s recent announcement to raise wages, there is little to help improve margins.

Europe

Economic weakness in both France and Germany along with a massive consumer confidence drop in Russia pulled sales down by 1.1% and operating income by 11%. A strong US dollar doesn’t help the company either. The only good news is coming from the UK where sales were up in 2014.

Asia/Pacific, Middle East & Africa

Supplier issues in China hit the company’s sales by 4.8% and operating income by 44%. While China is a very promising country for burgers, supplier issues may slow down MCD enthusiasm.

Other countries including Canada and Latin America as well as Corporate

McDonald’s restaurants are 80% owned by franchisees as followed:

57% conventional franchisees

24% licensed to foreign affiliates or developmental licensees

18% are company owned.

Source: McDonald’s website.

At first glance, I’m under the impression of looking at a company that was once the perfect example of a successful business model but the star seems to have dimmed a little. Let’s break down some numbers to see what MCD has to offer its shareholders.

 

Ratios

Price to Earnings: 20.02
Price to Free Cash Flow: 22.42
Price to Book: 7.23
Return on Equity: 31.81%

 

Revenue

MCD revenue

Revenue Graph from Ycharts

As you can see, the company seems to have hit a plateau since 2012. A stronger US dollar, rough competition and global economic slowdown explain why MCD is finding it hard to sell more burgers. The company is also struggling to deliver an updated menu that would help grab back market share from its competitors.

 

Earnings and Dividends

MCD earnings and div

Source: Ycharts

We can see in the previous graph that both sales and earnings are slowing down since 2014. The dividend payout has increased significantly but we can now wonder if the company will be able to maintain such a pace. The payout ratio hiked significantly over the past 12 months. Management has been talking about “challenging markets” for a few quarters now but doesn’t seem to be able to provide a long term solution.
Approximate historical dividend yield at beginning of each year:

mcd div yield

 

 

 

 

 

 

While the overall dividend growth over the past 7 years is impressive, we can see that the numbers have been back to a more normal pace over the past three years. Exactly at the same time when we can see the business model struggling while facing fierce competition. I don’t think we can expect a dividend growth of over 5% in the upcoming years.

 

How Does MCD Spend Its Cash?

The company focuses on distributing cash to its shareholders through numerous consecutive years of dividend increases along with a strong share buyback program. In the last quarter of 2014, the company had redistributed 1.8 billion alone. In 2014, management announced they will redistribute a total of 18 to 20 billion to shareholders through dividend payments and share buybacks. MCD also wants to refranchise a total of 1,500 restaurants and reallocate resources to higher growth initiatives.

Regardless of the business’ recent slowdown, MCD keeps generating a high level of cash flow and will use its liquidity to reward investors for their patience.

 

Balance Sheet

McDonald’s shows a strong balance sheet. McDonald’s Debt to Equity ratio is fairly low at 1.667, long term debt is only 2.8 times its average net income and (obviously) the MCD current ratio is in very good standing (1.5). The company’s biggest assets are not its burgers, coffee offerings or its branding. The company’s biggest asset is its real estate properties. With over 33B in buildings and land, the company owns some of the best locations in the world for retail business.

 

Investment Thesis

An investment in MCD today is an investment to build a core dividend growth portfolio. The company will not be your home run this year and will not post double digit growth. However, the business will definitely pay a higher dividend next year and its payment is not at risk for the moment.

 

Risks

I see a long term risk for MCD in that it hasn’t proven to the market it can reinvent Mickey D and generate growth. While the McCafé has been a good addition to its menu, it doesn’t seem to be enough to grab market share in this highly competitive industry.

Healthy food trends are also hurting MCD as burgers are not seen as a good choice for many consumers. While I’m pretty sure people will continue to eat burgers and fries, I’m also convince that fast food restaurants are no longer on the fast growing track anymore.

I’m afraid that MCD may become nothing more than a strong dividend payer that will lag the market in the years to come. Let’s see if the company is trading at an interesting value before coming to our conclusion.

 

Valuation

I’ll start the valuation process by looking at its historical P/E ratio. This will give me an indication of where the market sees the stock:

MCD PE ratio

The company’s valuation seems to be at its highest point since 2006 (excluding the market crash of 2008). The stock seems to be one step away frombeing overvalued at the moment using the P/E approach.

Since my goal is to buy dividend stocks, I always use the Dividend Discount Model to value a company. Since the company shows a strong balance sheet and because the company owns lots of real estate property, I will use a discount rate of 9%. While the 7 years dividend growth is standing at 18%, I don’t think it’s fair to expect such high dividend increases for the future. A 5.5% dividend increase seems more reasonable and achievable considering the recent payout ratio. Here’s what the Dividend Toolkit Dividend Discount Model Table gives me:

mcd intrinsic value

 

The stock seems fairly price with a discounted rate of 9% but if you are more concerned about its lower margins and use a higher discount rate, you quickly put MCD in the overvalued stock category.

 

Conclusion

Overall, we can say MCD is not a trading bargain at the moment. The price/earnings ratio is a bit high and the DDM gives a fair price considering my assumptions. The hope of more franchise restaurants in China along with massive share buybacks is maintaining the current stock price level. The fact that MCD is the leader in the breakfast industry and the strong dividend payment will continue to attract investors, I can see the company being part of a core conservative portfolio to provide both stability and good quarterly payments.

However, higher commodity prices related to the food industry combined with aggressive competition and increasing wages are all factors that will slow down McDonald’s profitability over the upcoming years. If I had $10,000 free in my investment account, I would not use it to buy MCD. I think it would be safe to wait for another year to see if the company is doing more than a simple step in the right direction.

Full Disclosure: As of this writing, MCD is part of our DSR Portfolios.

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Apple – A Techno Stock for Dividend Investors

Apple (AAPL) Inc designs, manufactures, & markets mobile communication & media devices, personal computers, portable digital music players and sells a variety of related software, services, accessories, networking solutions & third-party digital content.stock report

-Seven Year Revenue Growth Rate: 40.85%
-Seven Year EPS Growth Rate: 33.64%
-Seven Year Dividend Growth Rate: N/A%
-Current Dividend Yield: 1.67%
-Balance Sheet Strength: Extremely Strong

Overview

While it may seem like that everything has been said about Apple, it is not the case from a dividend growth investing perspective. This is why today, I’ll not only take a look at the fast growing and innovative company that Apple is but more about the future cash distribution machine it will become over the next 10 years.

Business Segments

The strongest asset Apple has is definitely its brand. Apple’s brand is known across the world and for a good reason; all of their products are well designed, well thought out and, most importantly, they interact perfectly in the most beautiful product ecosystem ever created. In this ecosystem, we find the following products:

iPhone, iPad, iPod, Mac, iTunes & App Stores, iCloud, Apple Pay, Apple Watch & Apple TV and Operating System Software. As you can see, Apple wouldn’t be the biggest company by market capitalization if it didn’t sell iPhones:

 

apple product per revenue

 

I like to say that Apple used to sell Macs as it now only represents 11% of its total revenue. The tablet sales have been a concern for AAPL over the past couple of years. Therefore, company results are highly dependent on how many iPhones it sells.

Ratios

Price to Earnings: 16.5
Price to Free Cash Flow: 12.22
Price to Book: 5.92
Return on Equity: 36.70%

Revenue

aapl revenue

Revenue grew at an incredible annualized rate of 29.34% over the past 10 years. The company will probably continue to raise revenues in the future but not at this pace. Over the past three years, the annualized growth has normalized to 5.31% which is still pretty solid.

The product integration increases the volume of sales per client. Therefore, each time Apple sells a product to a new customer, the chance of seeing him buy a second, third and fourth product is very high.

Earnings and Dividends

aapl earnings

As you can see, AAPL is not close to becoming the next aristocrat as its first dividend payment was made in 2012. Pressured by the market and more especially by Carl Icahn, Apple finally accepted to share a part of its ever growing bank account. The rate has been quite modest over the year.

Approximate historical dividend yield at beginning of each year:

aapl historical dividend yield

 

 

 

 

 

 

Due to another stock rally, the stock is currently yielding a relatively small yield of 1.50%. But what I really like about this future dividend grower is the fact that dividend is now increasing significantly each year and the company has plenty of room to continue its growth since the payout ratio is around 25%. You can then expect 10% dividend growth for several years without being worried.

aapl payout ratio

By looking at the previous graph, we are in a better position to appreciate AAPL as a dividend stock. Earnings have grown strongly over the past five years and the current environment will help Apple to rise to new highs. Most importantly, revenues are following a similar trend.

How Does AAPL Company Spend Its Cash?
Well the biggest problem with AAPL is that it doesn’t spend most of its cash. The company is generating an annual free cash flow of $60B. From this cash flow, AAPL distributed 10.5 billion in 2013 and 11 billion in 2014. The company also repurchased approximately for 22 billion of its stock. This means that 30 billion hasn’t been redistributed to investors. I bet you won’t be surprised to find almost 14 billion sitting in cash and another 11 billion in short term securities on its September 2014 balance sheet.

Apple has always remained a very cautious company with its cash. While many dividend investors ignore Apple for this reason (as they expect a higher distribution), I prefer buying a company that will always increase its payout and continue to have a clean balance sheet.

Balance Sheet

Apple’s balance sheet is very strong. The debt on equity ratio is sitting at 1.124 and the company could pay its long term debt in 5 years without blinking. The long term debt on debt income ratio is at 0.4409. You might think AAPL had included a huge goodwill value on its balance sheet since their brand is so powerful but only 4 billion out of a total asset of 231 billion is shown as goodwill. The company has virtually no debt as the long term debt of $29B could be paid off simply by writing a check from short term securities and the cash account.

Investment Thesis

The reason to buy Apple is not because it sells a great smart phone. It is not because tablets and other electronic device will continue to drive consumers to their stores. It is not also because AAPL is continuously innovating with new products or services such as the iWatch and Apple Pay launched recently. Those could all be good reason for a growth investor, but not for a dividend investor.

As a dividend investor, I’ve purchased this stock because of the company’s diversified product ecosystem. Buying an Apple product makes you want to buy another one and build your ecosystem at home. The integration is easy to do and generate efficiency to a maximum. My wife lost her phone not so long ago and I had to do was to pick-up my daughter’s tablet to find it within seconds.

The ecosystem drives the customer to buy more products and repeat purchases over time. Therefore, once their phone, iPod or tablet is up for a new one, many customers will go back to Apple because they know they will be able to sync their new purchase once back home without any headaches.

This ecosystem is the main reason why the company will continue to raise their dividend in the future as it will eventually become a more “stable” business that won’t surge at any moment. The easy money with Apple is definitely gone, but it doesn’t mean it can’t do well in your portfolio.

Risks

As with any techno stocks, AAPL is vulnerable to evolution. In five years from now, we might even not talk about smart phones anymore as consumers will want to buy something else. We saw many techno giants fall for this reason and AAPL is always one fail away to see its profitability drop. This is one of the reasons why it keeps so much cash in hand.

The second risk for this company is its dependence on the smartphone business. The stock rallied recently because sales in China surprised the market and there is a bigger hype since Samsung (it’s main competitor in the smartphone industry) is struggling with its dozen product launches.

Conclusion and Valuation

To value the company, I’ll first start with the historical PE ratio of AAPL for the past ten years:

gpc pe ratio

As you can see, the “new” value for this company is now around 17 to 20 times its earnings. The market has calmed down its expectation and the price is more reasonable. Considering today’s market, the stock seems cheap. It is currently trading near its lowest level since 2005 and the overall market is slightly overpriced. Regardless if the stock price as gone up by about 100% over the past three years, AAPL is not overpriced yet.

In order to have a better idea of its valuation, I’ll use the Dividend Discount Model. I use the table found in my Dividend Toolkit to determine the value based on the dividend paid by Apple. I use a discount rate of 9% since it will become a very stable business in the future and there is lots of cash flow generated by its business model. I expect the dividend to grow by 10% over the first 10 years and then it should reduce its pace to 7%. This gives me a fair value of $127.90.

aapl intrinsic value

 

Here again, the stock seems to be fairly price and maybe slightly under priced.

Since using both methods leads me to the same result; I conclude AAPL is a good buy at $125. The company shows strong growth potential and the dividend payout future for this stock is solid.

Full Disclosure: I hold AAPL in my DSR Portfolio

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Genuine Parts – Strong Company; Overpriced Stock

Genuine Parts Co (GPC) is a service organization engaged in the distribution of automotive replacement parts, industrial replacement parts, office products and electrical & electronic materials. This dividend aristocrat has an interesting growth model combining small but recurring acquisitions added to internal growth.

-Seven Year Revenue Growth Rate: 3.80% stock report
-Seven Year EPS Growth Rate: 5.72%
-Seven Year Dividend Growth Rate: 5.00%
-Current Dividend Yield: 2.33%
-Balance Sheet Strength: Strong

Overview

Genuine Parts (GPC) was founded in 1928 and is part of the dividend aristocrats. The company has increased its dividend payout for 58 consecutive years. The company shows around 37,500 employees across 2,600 operation sites.

Business Segments

The company is divided into four business segments:

 

gpc net sales by segment

The automotive segment is the most important with 53% of overall sales. The company offers over 427,000 different parts through its UAP NAPA stores. They also market and distribute their replacement parts. GPC is also present in Asia under GPC Asia Pacific.

The industrial segment is operated under the Motion Industries brand. They distribute a variety of industrial parts such as bearings, mechanical and electrical power transmission, hose and hydraulic components. They are present in all kinds of industries from food and beverage to forest as well as healthcare industries.

The Office Products segment is headquartered in Atlanta and operates under the name of S. P. Richards Company. The company is engaged in the wholesale distribution of a broad line of office and other business related products through a diverse customer base of resellers.

The Electrical / Electronic Materials Group is the smallest GPC business division with only 4% of overall sales. It provides distribution services to OEM’s, motor repair shops, specialty wire and cable users, and a variety of industrial assembly markets.

Ratios

Price to Earnings: 21.86
Price to Free Cash Flow: 21.94
Price to Book: 4.31
Return on Equity: 20.88%

Revenue

gpc revenue

Revenue grew at a rate of 3.80% per year on average over this period. Since 2010, we have a steady uptrend as the economy strengthened. The automobile industry went through an important recession since 2008 but sales are now increasing. The automotive parts business is linked to the automobile industry and this is why GPC benefits from the current economic environment. The bulk of GPC’s revenue growth comes from its automotive part business while other segments have faced various challenges. The company has acquired smaller players in the industrial parts industry to boost their sales in the upcoming years.

Earnings and Dividends

gpc earnings and dividends

The previous graph explains how EPS growth is strong at GPC. While we have a continuously increasing dividend paid (red line), the dividend payout ratio slowly decreases (orange line). We also see how the dividend yield is slowly decreasing as well. This is a result of the stock price continuously increasing on strong quarterly announcements throughout the past five years.

Approximate historical dividend yield at beginning of each year:

gpc dividend yield

 

 

 

 

 

How Does GPC Spend Its Cash?

Genuine Parts shows a balanced model of acquisitions, shares repurchased and dividend growth. Their business model is based on buying small competitors each year. GPC benefits from exceptional integration abilities, turning their acquisitions into strong assets. In 2014, they bought Garland C. Norris, EIS, Electro-Wire and Impact products. GPC continually looks for companies to buy with revenues in the range of $25M to $125M. Small acquisitions ensure external growth each year without hurting the balance sheet too much.

The company also considers its investors. In 2013 it has repurchased 1.5 million shares and approved a 10.7 million share buyback program on December 31, 2013. In addition to stock buyback programs, the company also increases its dividend year after year.

Balance Sheet

Genuine Parts shows a strong balance sheet. GPC has a Debt to equity ratio of 1.385 and a current ratio of 1.536. Despites its history of acquisitions, goodwill counts for 10% of total assets.

Investment Thesis

Genuine Parts is a leader in auto parts and should benefit from the current positive economic environment in the US. The company is able to grow both from internal sources and through acquisitions. The low interest rate environment improves acquisition terms and facilitates GPC’s crusade to grow ever bigger.

While the auto part industry will continue to ride alongside US automotive growth, the industrial segment will benefit from a growing US GDP. Studies have shown that when the price of oil drops significantly, it has a positive correlation to US GDP growth. Since we expect a growth around 3.9% in 2015, the industrial segment will certainly strengthen.

You can buy GPC for its strong dividend growth as it continues to show potential. The automobile industry should continue to grow in 2015-2016.

Risks

While I like the numbers, I don’t like the fact that GPC fails to meet analysts’ estimates from time to time. They were too optimistic at the beginning of 2013 and raised their guidance to disappoint 9 months later with lower than expected results. Then again, the stock shows a low dividend yield around 2.25%, this might turn off some investors.

Also, longer manufacturer warranties prevent GPC from acquiring clients with relatively new cars. Since warranties are extended for several years, many car buyers tend to go directly to the dealership instead of buying parts from UAP NAPA.

Conclusion and Valuation

When you look at the metrics, you can see that sales, earnings and dividend payments are all going in the same direction. We also believe in the car industry for 2015. GPC is another strong dividend aristocrat that should continue to raise its dividend this year. The company shows a strong balance sheet and the ability to increase its dividend for years. GPC not only shows good results but it also grows by acquisition. Their ability to integrate new companies is reflected in their earnings which show a steep uptrend. GPC will continue to be a leader in its industry and we won’t lack for car parts in the near future. Now, we have to determine if GPC is trading at a good value.

Using the Discounted Cash Flow Analysis, we look at GPC as a simple money making machine. The point is to assess the value of the company by considering its cash flow generation capacity. Consider the EPS to continuously grow by 5% for the next five years and then by 4% and a discount rate of 9%, we have a stock value of $97.78 which is very close to the current value on the market.

The Gordon Growth Model can be used to estimate ranges of fair value for the stock. The dividend growth rate averaged 5% over the last seven years and we can expect the company will continue in that range. Due to the strong nature of the balance sheet, a conservative discount rate can be used to focus the fair value assessment on risk-adjusted returns.

Using an expected 5.5% dividend growth rate and a 9% discount rate, the fair value is only $69.33, which is under the current share price of around $98.50. Due to the low yield, the model is particularly sensitive, and reducing the discount rate to 8% boosts the fair value to $102. On the other hand, if the company was able to grow its dividend by 6.5% per year instead of 5.5% we would reach the current value ($97.98 with a discount rate of 9%).

Finally, we can use the Price Earnings Ratio method. As we can see, GPC is not only trading over the S&P 500 historical average (between 16 and 17) but also around its highest valuation over the past ten years:

 

gpc pe ratio

Considering the Gordon Growth model and the P/E ratio valuation, I tend to agree that GPC is currently overpriced. An investor could wait for a dip in the market before acquiring a position in GPC.

Full Disclosure: As of this writing, GPC is part of our DSR Portfolios.

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