On Wednesday, the world’s largest restaurant company, McDonald’s (NYSE:MCD), announced its intention to increase the amount of capital it will return to shareholders in the next three years versus the previous three years. Shares fell more than 1 percent on the announcement.
Specifically, the company is planning on returning $18 billion-$20 billion to shareholders from 2014 through 2016. That’s about $6 billion to $6.7 billion per year — not bad for a company that is valued at $100 billion. This represents a sizable increase from the roughly $5 billion per year that the company has been returning to shareholders in recent years. The company has done the following with regards to dividends paid and stock repurchased in the past four years (numbers may not add up exactly due to rounding):
- 2010: $2.4 billion in dividends and $2.2 billion in stock repurchases for a total of $4.6 billion in capital returned to shareholders.
- 2011: $2.6 billion in dividends and $3 billion in stock repurchases for a total of $5.6 billion in capital returned to shareholders.
- 2012: $2.9 billion in dividends and $2.3 billion in stock repurchases for a total of $5.2 billion in capital returned to shareholders.
- 2013: $3.1 billion in dividends and $1.5 billion in stock repurchases for a total of $4.7 billion in capital returned to shareholders.
One thing to note about these numbers is that with the exception of 2011, the company’s net income exceeded the net amount of capital returned to shareholders.
Profits have held steady at around $5.5 billion per year over the past three years, and while analysts expect profits to rise somewhat over the next couple of years, it is unlikely that this profit increase will be sufficient enough to cover the “Plan to Win” capital allocation agenda. This means one thing: McDonald’s is going to be borrowing money in order to execute its plan.
This in itself isn’t a bad thing. In fact, one can make a relatively strong argument for it: namely, the prevailing long-term interest rate is so low that it makes sense for McDonald’s — a stable company with a strong credit rating – to borrow money in order to repurchase its own shares. This is a strategy that has been successfully implemented by several companies, including:
- Autozone (NYSE:AZO)
- Lorillard (NYSE:AZO)
- Direct TV (NASDAQ:DTV)
However, there is one difference: These companies were all growing their sales and their earnings, whereas McDonald’s hasn’t done so in recent years.
Again, analysts expect the company to grow its earnings in the next couple of years, but at this point in time it is difficult to see what the driving force behind this earnings growth will be. One of the problems McDonald’s has is that its food is perceived to be relatively unhealthy, and fast food companies that have been marketing to the constituency of healthy eaters (e.g., Chipotle Mexican Grill (NYSE:CMG) and Panera Bread (NASDAQ:PNRA)) have been much better long-term investments with growing sales and profits.
McDonald’s attempted to rescue its image by offering salads, apple slices, milk, and orange juice, but these products are clearly secondary to the image of burgers and fries that has made the company what it is today.
With these points in mind, one has to wonder whether an investment is worth making because the company is in a position to financially manufacture shareholder value as opposed to actually creating it by improving its business operations. There is no doubt that it can work for a while, but it certainly cannot work indefinitely.
So the appeal of McDonald’s shares is the fact that they are more or less bond proxies with the potential for superior returns. But if bond yields begin to rise McDonald’s shares will become less appealing, and investors will start to abandon the company.
Disclosure: Ben Kramer-Miller has no position in McDonald’s or in any other stock mentioned in this article.