Should You Be Buying This Restaurant Stock?

Anjali is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Greenlight Capital's founder and president, David Einhorn made a short case for the shares of Chipotle Mexican Grill (NYSE: CMG) at the value investing congress earlier this month and as a result the stock has seen a ~10% downfall. This is not the first time Einhorn has publicly bashed a company. He received extensive coverage in the financial press for short selling stocks like Allied Capital, Lehman Brothers and Green Mountain Coffee Roasters. Einhorn's main argument for shorting Chipotle is that YUM! Brands (NYSE: YUM) Taco Bell is going to succeed in taking the market share from Chipotle Mexican Grill. Let's analyze if that's indeed the case and whether YUM Brands is a good buy at the current levels.

If we go by the same store sales growth, Taco Bell is certainly doing better than Chipotle as well as Jack in the Box (NASDAQ: JACK) owned Qdoba Mexican Grill. In the second quarter, Taco Bell posted an impressive Same Store Sales (SSS) growth of 13% in comparison to Chipotle's 8%  and Qdoba Mexican Grill's 3%. Thus, it is evident that Taco Bell is gaining solid consumer traction in mexican food business. Taco Bell has more locations and its cantina bell menu is almost similar to chipotle but with 35% lower prices.  Thus, there is no doubt that what Einhorn is saying is bound to happen. Moreover, Yum! Brands' Q3 results further support Einhorn's bearish case. Yum! Brands' Q3 EPS was better than the consensus estimates by $0.20. Moreover, the company reported a 7% increase in Taco Bell's SSS which is a healthy number for a chain as large as Taco Bell. The following are the key reasons why I am bullish on Yum! Brands.

Balanced Growth in Domestic Market

Yum! Brands’ U.S. business looks good as the domestic strength continued in the current quarter with all the three brands posting good same store sales growth. Much has been talked about the increasing popularity of Taco Bell, however this was not a Taco Bell-only quarter as the blended U.S. SSS rose 6% with Taco Bell up 7%, Pizza Hut up 6% and KFC up 4%. With all the three brands showing positive results, I think the company will sustain its momentum going forward as well.

Strong China Profit Growth Despite Investments

Yum! Brands is going strong in China and posted a strong profit growth of 24% in-spite of a significant ramp up in new unit development (the company has raised its 2012 expansion target from at least 700 to at least 750 restaurants in China). The restaurant level margins in China were up 10 bps despite 50 bps drag from recently acquired Little Sheep. Lower inflation and the impact of previously disclosed prices helped margins. Strong check growth and restaurant-margin improvement suggest that consumers are adapting to the higher prices instituted in the past 12 months. I think the visibility in China has improved with pricing in place and a ramp-up in new unit growth and the company seems to be on track for double digit revenue growth in 2012 and 2013.

Penetration into Emerging markets

Yum Restaurants International (YRI) is becoming an increasingly important part of the company’s global growth strategy. Last quarter, YUM set a new goal to open over 1,000 new restaurants (up from 900) in YRI markets with over 65% expected to come from high-growth emerging markets. This quarter, ~69% of new openings (or 124 units) occurred in emerging markets, up from 66% or 127 units in 3Q11. Emerging markets are showing good results and I see strong growth prospects as the company continues its push into high-growth emerging markets.

A lot of investors looking for investing in Yum Brands post Einhorn presentation are concentrating on the company’s Mexican food business. Let's analyze the forward PE, dividend yield and next year's expected growth of YUM Brand and two other listed Mexican food companies- Chipotle and Jack in the Box.

<table> <tbody> <tr> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>Chipotle Mexican Grill</strong></p> </td> <td> <p><strong>Yum Brands</strong></p> </td> <td> <p><strong>Jack in the Box</strong></p> </td> </tr> <tr> <td> <p>Forward PE</p> </td> <td> <p>26.3</p> </td> <td> <p>18.98</p> </td> <td> <p>16.99</p> </td> </tr> <tr> <td> <p>Dividend Yield</p> </td> <td> <p>0</p> </td> <td> <p>2.00%</p> </td> <td> <p>0</p> </td> </tr> <tr> <td> <p>Growth Next Year</p> </td> <td> <p>20.80%</p> </td> <td> <p>14.40%</p> </td> <td> <p>5.30%</p> </td> </tr> </tbody> </table>

Yum! is trading at a slight premium to Jack in the box. However, I believe Yum! deserves a higher premium to Jack in the Box as it offers significantly better growth next year and also provides a dividend. As far as Chipotle is concerned, I think the Street's estimates for next year's growth needs some correction as Chipotle is bound to lose market share to Taco Bell and its growth rate may not be sustainable and hence, a 27% premium to Yum Brands seems unjustified.  I believe that the Yum! Brands is undervalued given brand diversification, good product mix, stable domestic business and vast global growth opportunity, led by China and other emerging markets. Thus, I would recommend buying this stock.

AnjaliPaliwal 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 and Jack in the Box. 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.

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