As an investor, I especially appreciate companies with strong brand recognition. Brand strength helps businesses consistently grow over time and remain resilient in challenging environments. As leaders in their respective industries, Dividend Aristocrats masterfully embody this characteristic. These are S&P 500 index (SPX) components that have delivered at least 25 consecutive years of dividend hikes to shareholders. Operating or franchising over 40,000 locations globally, fast-food giant McDonald’s (MCD) is one of the most recognized Dividend Aristocrats, though its near-term upside appears limited.
Following its recent financial results, the company’s fundamental outlook remains respectable. McDonald’s impressive dividend growth track record also looks set to continue. The only factor I find concerning about the fast-food franchise is its valuation. As a result, I’m initiating coverage with a Hold rating.
McDonald’s Served Up Modest Growth in Q3
In a macro environment marked by heightened competition for fewer customers due to inflationary pressures, McDonald’s reported solid third-quarter earnings on October 29. The company’s revenue rose 2.7% year-over-year to $6.9 billion for the quarter, slightly surpassing the analyst consensus of $6.8 billion. Customer engagement via its MyMcDonald’s loyalty program and strategic promotions played key roles in driving this marginal topline growth.
The company’s adjusted earnings per share grew by 1.3% year-over-year to $3.23, exceeding the analyst consensus of $3.20. McDonald’s topline growth and share repurchases effectively offset a 110-basis-point contraction in the non-GAAP net profit margin to 33.8% for the quarter. These factors enabled adjusted EPS growth despite mid-single-digit increases in total operating costs and expenses for the period.
MCD’s Loyalty Program Can Power Future Growth
In the coming years, McDonald’s has tangible growth catalysts on its side that inspire confidence in its operating fundamentals. The major driving force for McDonald’s is its loyalty program. The company anticipates that its loyalty program will reach 250 million active users by the end of 2027. This is key because studies have shown that loyalty customers spend more money, more frequently, than non-loyalty customers. Improved loyalty adoption will be attained through a combination of McDonald’s reaching more customers via new locations and continued marketing efforts.
On the innovation front, the company remains receptive to evolving customer tastes. The company’s larger burger offering, dubbed the Big Arch, has shown encouraging results in its initial three international markets of Portugal, Germany, and Canada. Thanks to the success of this pilot, McDonald’s plans to deploy the Big Arch more quickly into additional international markets in 2025. Finally, the recent E. coli cases stemming from slivered onions in a handful of U.S. states appear to have been quickly contained. Since no E. coli was detected in sample beef patties provided to the Colorado Department of Agriculture, McDonald’s returned Quarter Pounders to menus across its restaurants late last month.
Looking forward, the adjusted EPS outlook for McDonald’s is healthy. The company’s adjusted EPS is expected to rise by 6.6% in 2025 to $12.60. Another 8.9% growth in adjusted EPS to $13.73 is anticipated for 2026.
McDonald’s Has More Dividend Growth Potential Ahead
McDonald’s reputation as a dividend grower is another impressive attribute. Last month, the company announced a 6% hike in its quarterly dividend per share to $1.77. This marked the 48th consecutive dividend increase, putting the company just two years away from reaching the 50-year milestone required to be a Dividend King.
Furthermore, McDonald’s 2.3% dividend yield registers more than 100 basis points above the 1.2% yield of the S&P 500 index. The company’s payout ratio is also expected to remain sustainable, around the mid-50% range for 2025. This positions McDonald’s to grow its dividend at approximately the same rate as its earnings for the foreseeable future, which is why I anticipate 6% to 7% annual dividend growth over the next few years.
MCD Enjoys an Investment-Grade Credit Rating
McDonald’s appeal grows even more considering its financial fortitude. The company’s interest coverage ratio through the first nine months of 2024 was 7.9. This is important because it shows that McDonald’s has the ability to comfortably meet its financial obligations. That explains the BBB+ credit rating from S&P Global (SPGI) on a stable outlook, which puts the company at a low risk of bankruptcy in the coming years.
McDonald’s Stock Could Be Fully Valued
As I noted from the start, the one major drawback to McDonald’s stock now is arguably its valuation. Shares are trading at a forward P/E ratio of 24, which aligns with its 10-year average P/E ratio of 24.2. To be clear, McDonald’s could rise a bit higher if future results further improve sentiment. Over the long run, though, I find it difficult to envision fair value exceeding a P/E ratio of 24. Therefore, the overall risk-reward ratio leaves me neutral on McDonald’s anywhere around $300 a share.
Is McDonald’s Stock a Buy or Sell?
Shifting to Wall Street, analysts have a Moderate Buy rating consensus on McDonald’s. Among 26 analysts, 16 have issued Buy ratings and 10 have assigned Hold ratings in the past three months. The average 12-month MCD price target of $321.00 suggests that McDonald’s could have a 6.34% upside from the current share price.
The Takeaway
In conclusion, McDonald’s remains a strong and resilient company with solid growth drivers, including its loyalty program and dividend track record. While its fundamental outlook and financial strength are impressive, the current valuation limits the stock’s near-term potential. As a result, I maintain a neutral sentiment toward McDonald’s, as I believe the risk-reward ratio around $300 a share does not offer an ideal entry point. I would consider upgrading my rating if the stock sees a pullback to a more attractive valuation level.
