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Remain Bullish on McDonald's

- By Faisal Humayun

Investment overview

McDonald's (MCD) is a value creator for long-term investors and the stock has done well in the recent past in terms of stock upside. From near-term lows of $110 on Oct. 20, 2016, the stock has moved 17% higher to current levels of $129.

I believe McDonald's has more upside in the medium to long term as the company recently unveiled a new growth plan on March 1.


McDonald's currently has a dividend payout of $3.76 per share, translating into a dividend yield of 2.9%. The dividend is sustainable and can potentially increase in the coming years.

As broad markets surge higher, I believe investors should consider reallocating some funds from high beta stocks to low beta stocks. McDonald's has a beta of 0.73. While I am not suggesting any significant market correction is coming, investors need to remain cautious. Stocks like McDonald's, Procter & Gamble Co. (PG) and Johnson & Johnson (JNJ) serve as relatively safe investments.

Gains through digital enhancements

In the recent past, restaurant chains have expanded their digital capabilities in order to attract customers. Starbucks (SBUX) introduced mobile ordering, which has seen positive feedback even though the company needs to further improve the system's efficiency.

McDonald's is also targeting digital capability enhancement as one of the ways to attract customers. Customers will be able to place orders directly through a mobile app for pickup or have a kiosk recognize their app profile. The company plans to launch this initiative in 20,000 restaurants in some of its largest markets, including the United States, by the end of 2017.This is likely to have a positive impact on sales.

Additionally, McDonald's already has drive-thru windows. These combined with pick-ups are likely to contribute to growth in the medium to long term. The digital strategy is in sync with the company's core objective of retaining existing customers and regaining lost customers.

Since the company knows it cannot solely depend on its digital initiative to regain lost customers, McDonald's is working on improving its quality, convenience and value.

Other key initiatives for growth

The company is also working on food deliver, which is a significant step toward enhancing sales. In McDonald's top five markets (the U.S., France, the U.K., Germany and Canada), nearly 75% of the population lives within three miles of a McDonald's. This is the single biggest advantage for the company when it comes to home deliveries. Even in other markets, the company's deliveries have been increasing at a strong pace. In China, deliveries have tripled since launch in 2008 and in 2016, the deliveries business grew 30%. Therefore, this is a key initiative that is likely to support McDonald's growth in the medium to long term.

Another initiative that was announced at the onset of the company's reorganizing plans was refranchising. The company is on track to refranchise 4,000 restaurants by the end of 2017. This will bring its global franchised percentage to approximately 93% and does have a positive impact on the key margins. In addition, McDonald's achieved more than $200 million in savings through fiscal 2016 and is on track to reducing net general and administratives costs by $500 million by the end of 2018. Even if there is gradual expansion in margins, the impact on operating cash flow is likely to be meaningful.

Shareholder value creation

At the end of fiscal 2016, the company achieved its three-year target of $30 billion cash returned to shareholders. The company has set a new target of $22 to $24 billion returned in the next three years.

McDonald's is a quality stock for dividend income investors and sustained value creation is likely to come through dividends as well as share repurchases. I believe the three-year target for shareholder returns can potentially be revised to the upside if the company's plans for refranchising, digitalization, better menu spread, home delivery and better customer experience are successful in the coming years.

Conclusion

McDonald's is a quality dividend stock. Even after the recent upside, the stock is trading at attractive levels.

Significant penetration is possible in high-growth markets like China and India. If the company moves forward with a strategy focusing on local taste preferences, along with a healthy menu, new markets can be game changers.

Disclosure: No positions in the stocks discussed.

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This article first appeared on GuruFocus.