Blue Chip Stocks: Earnings jump to fuel buybacks for McDonald’s Corp.

A simplified menu and plans to lower operating costs will allow the fast-food giant to increase both buybacks and dividends.

The fast-food industry faces several long-term challenges. These include the consumer shift to more nutritious foods and new laws to increase minimum wage rates.

McDonald’s has a history of adapting to changing trends. The new plan is to increase sales through better food and customer service. It’s already paying off. The company is also cutting its costs by transferring more of its outlets to franchisees.

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McDonald’s will use most of the savings for share buybacks and dividends. That should continue to push the stock higher.

MCDONALD’S CORP. (New York symbol MCD; www.mcdonalds.com) is the world’s largest operator of fast-food restaurants, with 36,500 outlets in 120 countries. It serves a wide variety of food, but is best known for its hamburgers and french fries.

The company’s sales rose 4.1%, from $27.0 billion in 2011 to $28.1 billion in 2013. Sales then fell to $27.4 billion in 2014, and to $25.4 billion in 2015.

The recent decline was mainly due to stronger competition from from new fast food chains such as Chipotle and Shake Shack. The higher U.S. dollar has also hurt the contribution of McDonald’s international outlets. They supply two-thirds of total sales.

Earnings fell 0.7%, from $5.50 billion in 2011 to $5.46 billion in 2012. The company is an aggressive buyer of its own shares, so per-share earnings rose 1.7%, from $5.27 to $5.36. Earnings improved to $5.55 a share (or a total of $5.6 billion) in 2013. However, earnings then fell to $4.82 a share (or $4.8 billion) in 2014, and to $4.80 a share (or $4.5 billion) in 2015.

In response to slowing sales, McDonald’s has simplified its menus. That has helped speed up service, particularly at its popular drive-through locations. The company has also launched successful new products, such as premium coffees.

In addition, McDonald’s is improving the quality of its foods. This includes a complete switch to cage-free eggs in the U.S. and Canada by 2025. The company purchases about two billion eggs in the U.S. annually for its Egg McMuffins and other products, and its Canadian business buys roughly 120 million.

McDonald’s also plans to sell 4,000 company owned outlets to franchisees. As a result, those partners will operate 95% of the chain’s restaurants by 2018, up from 80% today. This will lower the company’s operating expenses, and free it from maintaining and upgrading these outlets.

Another part of the growth strategy involves cutting $500 million a year in administrative costs starting in 2017. That’s $200 million more than McDonald’s earlier goal. These initiatives are starting to work. In the three months ended March 31, 2016, the company’s sales fell 0.9%, to $5.9 billion from $6.0 billion. However, excluding exchange rates, sales gained 3%. Overall same-store sales rose 6.2%.

In the U.S., same-store sales improved 5.4%. That’s mainly due to the success of new all-day breakfast offerings and the McPick 2 value menu.

Same-store sales also gained 5.2% at McDonald’s International Lead markets (developed countries such as Canada, Australia, the U.K., France and Germany).

As well, same-store sales at its High Growth Markets (including China, Italy, Korea, Poland, Russia, Spain, Switzerland and the Netherlands) rose 3.6%.

Blue Chip Stocks: Earning jump 35%

Earnings in the quarter rose 35.4%, to $1.1 billion from $811.5 million a year earlier. Earnings per share gained 46.4%, to $1.23 from $0.84, on fewer shares outstanding. If you exclude unusual items, earnings per share rose 26%. The company plans to add 500 new restaurants in 2016. Including upgrades to existing locations, it expects to spend $2.0 billion on these projects.

Over the next five years, McDonald’s also plans to open 1,500 new restaurants in China, Hong Kong and South Korea. It currently has 2,800 outlets in these markets.

The new restaurants will allow the company to profit from Asia’s population growth. Moreover, people in the region are moving to bigger cities.

McDonald’s sound balance sheet will support its expansion plans. Its long-term debt of $23.4 billion (as of March 31, 2016) is a moderate 22% of its market cap. It also held cash of $3.3 billion, or $3.77 a share.

The company’s $3.56 a share dividend yields 2.9%. McDonald’s has increased the payout each year since it began paying dividends in 1976.

Rising dividends are part of McDonald’s plan to spend $30 billion on dividends and share buybacks between 2014 and 2016. It has already spent $20.3 billion as of March 31, 2016.

In the U.S., the company expects its ingredient costs will fall 3.5% to 4.5% this year. That will help offset the negative impact of currency exchange rates.

As a result, McDonald’s earnings for all of 2016 should rise to $5.45 a share. The stock trades at 22.6 times that estimate. That’s an acceptable multiple in light of McDonald’s new growth plan and well-known brands. The stock also trades at a more reasonable 20.3 times its projected 2017 earnings of $6.05 a share.

Recommendation in Wall Street Stock Forecaster: BUY

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Jim Bates

Jim is an associate editor at TSI Network. He is the lead reporter and analyst for The Successful Investor and Wall Street Stock Forecaster and a member of the Investment Planning Committee. Jim has held the Chartered Financial Analyst designation since 1992 and spent more than a decade at the Financial Post DataGroup before joining TSI Network. He has a Bachelor of Commerce degree from the University of Toronto.

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