McDonald's Corp (MCD) reported 12.6% higher Q1 sales at the end of last month on a comparable basis and significantly higher free cash flow (FCF). Along with its 2.1% yield and buybacks, these factors make MCD stock a value buy. Moreover, investors can play this by shorting out-of-the-money puts in order to create extra income.
On April 25, McDonald's said its sales rose 12.6% YoY on a comp basis. Moreover, its earnings per share (EPS) came in at $2.63, which beat expectations by 29 cents, according to Seeking Alpha.
Free Cash Flow Significantly Higher
Even more importantly, its free cash flow (FCF) was higher by over 10% on a YoY basis. For example, last year in Q1, McDonald's generated $1.73 billion in FCF, and this year it came in at $1.917 billion. That represents a growth rate of 10.7%.
Moreover, in the last 12 months ending March, McDonald’s produced $5.76 billion in FCF. That represents 2.73% of its $211 billion market capitalization - i.e., an FCF yield of 2.67%.
This shows that the company can easily afford its ample dividends and share buybacks. Its $6.06 annual dividend now yields 2.1% on its price today of $286.37 (March 23 mid-day).
In addition, McDonald's has bought back over $2.7 billion of its shares on a net basis in the past year, according to Seeking Alpha. That represents a buyback yield of 1.28% on its market cap of $211 billion.
Where This Leaves Investors in MCD Stock
As a result, shareholders are getting a total yield of 3.4%, including both its dividends and buybacks. That makes it attractive to long-term value buyers.
In fact, analysts' earnings forecasts for the company are $11.09 in EPS this year and $12.09 next year. At $286.37 today, that puts the stock on a forward P/E multiple of 25.8x for 2023 and 23.7x for 2024.
This is below its 5-year historical average multiple of 25.3x, based on Morningstar's calculations. So value buyers are able to get the stock at a reasonable price here.
In addition, investors can short out-of-the-money (OTM) put options in order to get a cheaper price as well as income.
Shorting OTM Puts for a Discount Buy-In and Additional Income
For example, for the expiration period ending June 23, which is 31 days from now, investors can short the $270 strike price puts at an attractive premium level. This strike price is 5.5% below today's spot price for MCD stock. That means that if the stock falls to this price on or before June 23, the investor who shorts this put option will be exercised and the cash they secured will purchase the stock at $270.00
However, the premium received from selling short this strike price is $1.18 per contract. That means that the investor who secures $27,000 in cash and/or margin with their brokerage firm, can then enter an order to “Sell to Open” the $270 strike price put. The account will then immediately receive $118.00
This works out to an immediate yield of 0.437% (i.e., $118/$27,000). If repeated for 12 months, that annualized out to a return of 5.244%.
Moreover, an investor who is willing to take on more risk can short the $275 strike price and receive $1.79 per put contract. That works out to an immediate yield of 0.65%, or 7.8% on an annualized basis.
However, this strike price is only 3.77% below today's price, which might mean that the investor will be forced to purchase the stock at $275. Nevertheless, even if that happens, the investor has a breakeven point of $273.21 (i.e., $275-$1.79 received), or 4.6% below today's price.
In other words, there are good ways to supplement the dividend and buyback yield that MCD stock offers by shorting OTM puts.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
