The Best Fast Food Stock
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Fast food restaurants are an interesting sector to look for easily identifiable investment alternatives. In most cases we have a formed opinion on how we feel about certain restaurants, and it’s not complicated to find new and attractive possibilities if you like that kind of food. Be careful though, your doctor is probably against too much “experimental research” on this kind of places.
Chipotle Mexican Grill (NYSE: CMG) is an of the most interesting growth stories in the sector. Not exactly a fast food chain, Chipotle is more similar to what is now called “fast-casual” food, meaning food quality and prices which are bit above quick service levels, but not too much. The average price check is around $10, for a meal at Chipotle Mexican Grill, and it includes burritos, bowls, tacos and salads made from higher quality ingredients than in typical quick service restaurants.
The company has found an interesting position by maintaining the basic speed and experience of the fast food industry, but offering higher quality food and better ecological and sustainability standards. Most fast food companies move into highly processed ingredients as they grow in size, but Chipotle has done exactly the opposite, focusing every day more on fresh ingredients for its tacos and burritos. Instead of looking for low cost suppliers, Chipotle has developed its own network of high quality providers of natural and environmentally sustainable food.
This strategy is obviously more expensive than the typical cost reduction road, but customers at Chipotle have been willing to pay some extra bucks to get better ingredients. Over the last years Chipotle has experienced double digit growth rates in comparable store sales, which is quite uncommon in this industry. The company has been tremendously successful in the last years, earnings per share increased by an almost 40% annually over the last five years.
And growth opportunities are not over for Chipotle, first quarter comparable store sales grew by an almost 13%, which means demand is strong and there is a lot of room for more expansion. The company opened ShopHouse Asian Kitchen in September 2011, its first Asian-Themed restaurant which looks like an exciting project.
If Chipotle can extend its reputation into other kinds of food besides Mexican, the company could experience some additional sources of growth and profitability. International markets could be another big opportunity for Chipotle, if the restaurant chain manages to be successful in other countries, investors in Chipotle could have many years of attractive growth rates ahead of them.
There is nothing wrong with the company, in fact it has very exciting prospects, but the shares are too spicy for my taste. At a P/E ratio above 55 Chipotle is very expensive in comparison to big fast food chains like Mc Donald´s (NYSE: MCD) and Yum Brands (NYSE: YUM), which are trading at a P/E of 16 and 20 respectively.
Growth opportunities are clearly better for Chipotle due to its smaller size, more innovative products and relative abundance of expansion opportunities, but the difference in valuation still looks too high even considering these factors. This burrito looks tasty, but I’ll wait for a pullback before placing an order, prices are just too hot.
There are some notable differences coming from the comparison between Mc Donald´s and Yum Brands. Mc Donald´s is quite cheaper at a P/E of 16 and a dividend yield of 3.2% versus a P/E of 20 and a 1.8% dividend yield for Yum Brands. The difference in valuations is probably related to growth expectations, analysts estimate a 9.8% increase in earnings per share for Mc Donald´s over the next five years and a higher 13.5% for Yum Brands in the same period.
Yum Brands, which owns KFC, Pizza Hut, and Taco Bell among others, has been expanding rapidly into emerging markets, and the company has built a leadership position in countries like China, where growth potential is clearly outstanding. The difference in valuation may be explained by better growth prospects for Yum, but Investors need to pay attention to what´s reflected in prices and how the situation may change over the following years.
Mc Donald´s is not likely to be happy with a second place in a country as big as China, so tougher competition via lower prices, more advertising and marketing expenses and better adaptation to the Chinese consumer is expected over the following years. Mc Donald´s has a much better position than Yum brands in domestic markets, and the company could extent that dominance into China as it gains knowledge and experience about Chinese markets.
Over the last five years Mc Donald´s did much better that Yum in terms of earnings per share growth, and it will certainly try to repeat that performance in the future. A powerful brand, unparalleled geographic presence and abundant financial resources are some of the factors which make Mc Donald´s an undisputable leader in its industry.
The company has managed to perform better that expected in the past, and it has not lost any of its competitive advantages. From a valuation point of view, Mc Donald´s looks very reasonably priced. Maybe Mc Donald´s is too safe or boring for aggressive investors looking for high growth, but from a risk and reward perspective it looks like the superior fast food stock.
acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of Chipotle Mexican Grill. Motley Fool newsletter services recommend Chipotle Mexican Grill, McDonald's, and Yum! Brands. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
