On May 29, McDonald’s (MCD) shares fell below $250 for the first time since mid-October 2023. A lot of restaurant stocks have been under pressure due to concerns with consumer spending and eroding pricing power after years of price increases.
The Dow Jones Industrial Average component has its challenges, but the stock hasn’t looked this cheap in years, and the dividend yield has shot up to an attractive 2.7%. Here’s why McDonald’s stands out as my top Dow Jones dividend stock to buy in June.
McDonald’s is as steady as it gets
When you think of the fast-food industry compared to sit-down restaurants and chains, you probably imagine lower prices and higher volumes with a value proposition centered around price and convenience. But McDonald’s is in a league of its own when it comes to profitability.
The company operates an extremely efficient franchise model. As of March 31, McDonald’s has 42,018 restaurants, but just 2,153 — or 5% — are company-owned and operated. McDonald’s owns the land and the intellectual property, and collects royalties from its food items and rent. It’s a win-win set-up for a proficient franchisee, who benefits from McDonald’s brand, supply chain, promotions, and more.
Ultimately, McDonald’s depends on its franchisees making money. But in the near term, the franchise model helps reduce risk for McDonald’s because so much of its business comes from the overall set-up rather than the day-to-day operations.
It’s hard to believe, but McDonald’s has a trailing-12-month operating margin of 45.8% — which is higher than that of Microsoft, Apple, Amazon, Alphabet, Meta Platforms, and Tesla. It means that McDonald’s pockets roughly 46 cents in operating income for every dollar in sales. But how?
McDonald’s franchise revenue is extremely high margin because its operating expenses don’t go to running those restaurants, but rather positioning those restaurants to succeed. McDonald’s Q1 2024 results showcase this dynamic well.
Revenue came in at $6.17 billion. About $2.36 billion of that was from company-owned and operated restaurants, and $3.72 billion was from franchised restaurants. Company-owned and operated restaurant expenses were $2.04 billion — meaning the margin on those company stores was 13.6%. But franchised restaurant occupancy expenses were just $627 million. Total operating costs and expenses were $3.43 billion — leaving $2.74 billon in operating income for a whopping 44.4% quarterly operating margin.
Understanding how McDonald’s makes money makes the business much smaller than it seems at first glance. For example, McDonald’s franchise sales were $28.8 billion in the first quarter of 2024. But franchise sales are not recorded as revenue by the company. Its actual revenue from franchises was, as mentioned, just $3.7 billion, which again is from licensing, royalties, rent, etc.
Franchisees buy into McDonald’s over the alternatives because it’s a good way to make money over several years if not decades. A few quarters of slowing growth don’t deter that proposition.
McDonald’s stock is a great value right now
McDonald’s business model generates steady inflows and is resistant to recessions. So naturally, the stock garners a premium valuation. In fact, its three -, five-, seven-, and 10-year median price-to-earnings (P/E) ratios are all above 25. However, the stock currently fetches a mere 21.8 P/E. McDonald’s stock is down over 13% year to date, which has made the valuation more attractive.MCD PE Ratio Chart
The earnings multiple is no accounting fluke. Analyst consensus estimates call for $11.29 in 2024 earnings per share (EPS) and $12.30 in 2025 EPS. Projections indicate earnings growth, not a decline, making McDonald’s a great value for investors who are willing to buy the dip.
Aside from its strong brand and inexpensive valuation, McDonald’s dividend is yet another incentive to hold the stock long-term. McDonald’s has raised its dividend every year for 47 consecutive years. The most recent raise, which was announced in October, increased the dividend by 10% to $6.68 annually — which amounts to a forward yield of 2.7%.
McDonald’s track record for consistent and sizable dividend raises, paired with the solid yield, makes it an excellent source for generating passive income.
A no-brainer buy
McDonald’s is one of the best-run, recession-resistant companies out there. But its advantages are well known, making buying opportunities hard to come by. The current sell-off in McDonald’s stock is mostly due to concerns surrounding its pricing power. There are only so many price increases a company can levy before consumers stop viewing it as a good value.
A good portion of McDonald’s first-quarter 2024 earnings call centered around pricing and creating value through meal bundles and digital offerings. Price is paramount McDonald’s. For its franchisees to thrive, customers need to view McDonald’s as a fast-food option that delivers on convenience and price.
Given the slew of price increases in recent years, McDonald’s is admittedly facing a challenging near-term period. But the long-term investment thesis, valuation, and dividend are simply too good to ignore. Investors looking for a steady performer to add to their portfolio should consider McDonald’s as a worthwhile blue chip dividend stock to buy on the dip.
— Daniel Foelber
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Source: The Motley Fool