The sheer scale of the McDonald’s (MCD) shareholder return program is astonishing. The firm has spent a cumulative total of $42.5b returning cash to its shareholders since the beginning of 2015. For those interested, roughly $14.5b of that went on cash dividends, with the rest on stock repurchases. Total net profit for the period amounted to just over $23b.
In light of that discrepancy, many McDonald’s shareholders will be tempted to channel their inner Jean-Claude Pitrel, a character in the Hollywood film Taken. When challenged by Liam Neeson’s character, the corrupt French cop replies something like this: “My salary is X. My expenses are Y. As long as my needs are met I do not care where the difference comes from”. Well, we know full well where the difference comes from in this case: debt. Net of cash, it stood at just under $13b at the start of 2015, rising to over $30b by the end of H1 2019. At first glance, that trend looks unsustainable.
That said, we also have to take into account the fact that McDonald’s makes a lot more money now than it did in 2015. Back then, the company made annual net profit of $4.5b. That had risen to $6b as of last year, albeit largely thanks to US corporate tax cuts. Analysts estimate that the company will make around $6.2b this year. Still, debt increased from around 2.9x earnings to 4.8x estimated earnings in that time. It looks like we are still firmly in the ‘unsustainable trend’ camp. That ratio just can’t keep going up and up forever.
For shareholders worrying that this represents irresponsibility on behalf of management, I would offer three counter points. Firstly, check out how much McDonald’s actually pays to service its debt. Back in 2015, the company paid $640m in annual interest, equivalent to an effective interest rate of 4% on it year-end debt position. That had risen to $980m last year, or around 3.2%. Despite net debt more than doubling, interest expense as a proportion of profit remains largely unchanged.
The second point worth remembering is that buybacks are not wholly cost ‘negative’ for the company. To illustrate what I mean by that, just think about the dividend, which should clock in at circa $4.65 per share this year. Now, the company has spent close to $28b eliminating around 200m shares since the start of 2015. If those shares still existed, we would be looking at an extra $930m in annual outgoing dividend cash. In a way, McDonald’s is actually saving money even though its interest bill is higher than in 2015. Note that this still holds true even at the 2015 annual dividend rate of $3.44 per share.
Finally, it is worth bearing in mind the nature of the company’s debt obligations. The vast-majority carries a fixed rate, so there is little-to-no interest-rate risk in total. Not only that, but well over half (around $19b) isn’t due anytime in the next five years. I would also add that McDonald’s would generate $1b per year in post-dividend free cash flow if it simply ceased buying back stock it.
McDonald’s stock currently trades around the $215 point. That makes for a price-earnings ratio of 26.8 which, needless to say, looks pretty steep. Things look even richer on a debt-adjusted basis. As said previously, the biggest risk to buying McDonald’s stock right now comes not from the business, or indeed its debt load, but the valuation.
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