I’ve become convinced that the best way to think about McDonald’s (MCD) and other established fast-food stocks is as cyclicals. Oh, not in the usual way where the fortunes of a company rise and fall with the cycles in the economy. No, I think the established fast food companies–the McDonald’s, the Burger Kings, and the Wendy’s of the world–seem increasingly to be a zero sum game where one company rises as it steals customers from competitors after the roll-out of some temporarily innovative product and then loses those customers back again to competitors as those companies roll out their own new initiatives.
McDonald’s is almost a test case of that way of thinking about the sector. From 2013 to 2016 the company estimates that it lost about 500 million customer visits as traffic at its restaurants fell for four consecutive years: down 1.6% in 2013, down 4.1% in 2014, down 3% in 2015, and down 2.1% in 2016.
Meanwhile Wendy’s (WEN), for example, was recording quarter after quarter of rising traffic and climbing same store sales on the strength of such offers as its super-cheap (sorry, I mean super-value) 4 for $4 menu.
In response McDonald’s has revamped its dollar menu and its 3 for $5 promotion , rolled out $1 drinks, offered its breakfast menu all day,and added a Archburger, a fresh-beef burger that will sell for $2.19 (instead of $3.79 for a Quarter Pounder with cheese or $3.99 for a Big Mac.) All this looks like it has ended the customer decline with customer counts rising 2% in the first nine months of 2017 compared to the first nine months 2016. (McDonald’s reports fourth quarter earnings before the market open on January 30. That will tell us how the year looked as a whole.)
The bounce back in customer visits as McDonald’s gets the advantage of weak comparables is one reason that I’m adding the stock to my Dividend Portfolio today with a target price of $203 a share. The stock closed at $176.12 on Friday, January 19.
The second reason is the potential for a big increase in the stock’s dividend–the trailing 12-month yield is 2.29%–as a result of the Tax Cuts and Jobs Act. McDonald’s raised its dividend by 7% back in September and even before the tax cuts there was good reason to expect the company to match that dividend increase in 2018. After all, thanks to the company’s continued efforts to franchise more of its restaurants, its operating margin was projected by Standard & Poor’s to climb to 39.5% in 2017 and to 44.9% in 2018 from just 32.8% in 2016. Add in a big cut in corporate tax rate–from 30% to 20% after the Tax Cuts and Jobs Act–and the company will have lots of cash to use for buybacks and dividend payouts. A 10% dividend increase would take the annual payout to $4.44 from $4.04 currently for a yield of 2.5% on the January 19 closing price.
And those two reasons are why McDonald’s is my seven stock of Christmas and an addition to my Dividend Portfolio at its 2018 rebalancing.
My first 12 days of Christmas Pick for 2018 was Amazon (AMZN). My second was Nektar Therapeutics (NKTR). The third was Southern Copper (SCCO). The fourth was Nvidia (NVDA) The fifth was Applied Materials (AMAT) The sixth Starbucks (SBUX). (And yes, I missed the deadline of January 5 for the end of the 12 days of Christmas.)