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A surprise entry for dividend aristocrats?

There are 51 companies in the S&P 500 that have increased their dividends for at least 25 consecutive years. This dividend aristocrats list holds many household names, but only one restaurant, McDonald’s (MCD). The restaurant business is notoriously difficult, but some industry companies could eventually join the ranks of dividend aristocrats.

For clients who seek individual stocks that will provide growing income, here are some things to look for: First, of course, is that the restaurant company pays a dividend (many don’t). Second, the company should have already started increasing its dividend annually. Third, and most important, the company should display solid growth in free cash flow.

Don’t expect FCF to rise every year. Fluctuations in capital expenditures can and do occur. The FCF trend line, however, should be rising.

Here are three restaurant stocks that could become dividend aristocrats. Share prices, dividends, and yields are as of the market close Sept. 28, 2017:

Dunkin’ Brands (DNKN, $53.28, indicated dividend: $1.29, yield 2.4%) franchises Dunkin’ Donuts and Baskin-Robbins outlets in more than 60 countries. Coffee operations are strongest in the Northeastern U.S. where the company is headquartered. Dunkin’ began paying annual dividends of 60 cents in 2012. It has raised it annually to the current indicated rate of $1.29. And free cash flow per share has risen at a compound annual growth rate of 14% over the five years ended 2016. Since the company franchises all of its stores, major capital expenditures should not be a factor. Management expects to increase Dunkin’ Donuts outlets in the U.S. to 17,000 over the coming decades from about 8,900 now. The company has ample room to expand in the West, Midwest, and South. Management is targeting faster overseas growth for its Baskin-Robbins brand.

Restaurant Brands International (QSR, $63.88, indicated dividend: 80 cents, yield 1.3%) was formed in 2014 by the merger of the world’s second-largest hamburger chain, Burger King, and Canada’s largest fast-food operator, Tim Horton’s. The company recently acquired fried chicken purveyor Popeye’s Louisiana Kitchen. The company is based in Canada, and trades on the New York Stock Exchange (all numbers are in U.S. dollars.) Restaurant Brands began paying dividends in 2012 and the company has raised its shareholder payments by a penny in each of the past 10 quarters. About 99% of QSR’s 23,000 restaurants are franchised, meaning capital expenditures should be minimal. Free cash flow per share has increased at a 9.7% compound annual growth rate over the five years ended 2016. Popeye’s has 2,800 locations worldwide (vs. 16,000 for Burger King), giving Restaurant Brands a lot of room to expand its newest chain.

Starbucks Corp. (SBUX, $54.50, indicated dividend: $1.00, yield 1.8%) sells premium specialty coffee at more than 26,000 locations worldwide. About half are company owned. Starbucks also sells coffee beans through supermarkets and has joint ventures that sell bottled coffee drinks and ice cream. Starbucks has paid a dividend since 2010. The initial dividend was at an annual rate of 20 cents a share. The company has raised it annually and it is currently $1.00 a share. Although Starbucks is shuttering its mall-based tea chain, Teavana, prospects are good for overseas expansion of its coffee business, particularly in China. Domestic operations should benefit from expanded use of its digital ordering and payment program and new products. Even though Starbucks incurs capital expenditures for its owned and operated shops, its free cash flow has climbed at a 24.2% CAGR over the five years ended fiscal 2016.

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