Fast-Casual Part 2: One to Own

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

The fast-casual concept has proven itself with a few big winners, particularly Five Guys, Chipotle, and Panera. This article is for those of us who did not jump on the fast-casual investing train early (me included). We missed out on the initial gains; where should we put our money? This is the second in a two-article series (the first can be seen here). Today, I will be looking at the Mexican, Central American, and South American inspired end of fast-casual: Chipotle Mexican Grill (NYSE: CMG), the Qdoba concept operated by Jack in the Box (NASDAQ: JACK), and the Taco Cabana and Pollo Tropical concepts run by Fiesta Restaurant Group (NASDAQ: FRGI).

Fiesta Restaurant Group

Fiesta Restaurant Group has had a tremendous run since Carrols Restaurant Group (NASDAQ: TAST) spun it off in Q2 of 2012. The stock price has almost tripled since then, and it’s no wonder: Pollo Tropical reported the highest same-restaurant sales growth in the fast-casual space, with a 3.8 percent increase over Q1 of 2012 (continuing a 14-quarter streak of comp increases). Taco Cabana, which has a menu of more traditional Mexican favorites (quesadillas, flautas, burritos, salad bowls, and tacos), grew same-store sales by a comparatively modest (but still impressive) two percent, the concept’s eleventh consecutive quarter of comp increases.

Fiesta Restaurant Group will open between 14 and 17 new corporate restaurants this year and is aggressively franchising internationally. Management’s plan is to “grow EPS in excess of 20% annually” via aggressive expansion and continued same-store sales increases.

Fiesta Restaurant Group is trading at a very high P/E ratio of 53.8, although, given that it is a high-growth stock, the ratio may be appropriate depending on your investing style. Personally, it’s a little pricey for me, especially given the high debt/equity ratio of 13. That aggressive expansion comes at a price, and in this case that’s a balance sheet that leaves something to be desired. Also, the company itself has not been around that long (although Pollo Tropical has existed since 1988 and Taco Cabana since 1978), so I would like to see a little more proof that management can deliver on these promises before committing.

Chipotle

Chipotle is making some great moves, including testing a catering service in Colorado (which will expand to the remainder of the company by September 1) and the rollout in California of a new vegetarian menu called Sofritas. Chipotle isn’t leaving the aggressive expansion to Fiesta Restaurant Group; management opened 48 new restaurants in Q1 of 2013 alone and intends to open between 165 and 180 new restaurants in 2013.

Chipotle’s sales grew by one percent on a same-restaurant basis in Q1 of 2013 compared to Q1 of 2012. Driven by higher operating margins, diluted earnings per share grew by over 24 percent in Q1. At $9.23, EPS for the trailing twelve months is almost double the 2010 EPS of $5.64. Chipotle has $700 million in cash and no debt – this company has the resources it needs to continue its aggressive expansion. At 39.8, the P/E ratio is high, but not nearly as high as Fiesta Restaurant Group’s. Given the strong balance sheet, still-aggressive expansion, and reasonable pricing, Chipotle is a definite buy.

Jack in the Box

Jack in the Box is the only restaurant of these three that isn’t wholly fast-casual; it operates both a burger concept (Jack in the Box) and the aforementioned Qdoba fast-casual concept. Jack in the Box operates on a fiscal year that ends in September, so Q2 of FY 2013 is the closest approximation for comparison to the Q1 numbers reported above. Qdoba reported a comp decrease of two percent in Q2. Qdoba already has a catering business, which represented 6.5 percent of sales for Q2 (and increased 11.5 percent compared to Q2 of 2012). Qdoba opened up 32 new restaurants (12 of them company-owned) during Q1 and Q2 – more new restaurants than Fiesta Restaurant Group, fewer than Chipotle.

In my mind, one of Jack in the Box’s primary challenges is differentiating Qdoba from Chipotle. Their Q1 promotion allowing guests to add queso to their burritos for free was a good first step, as it emphasized the fact that Chipotle does not have something comparable.

During the Q2 earnings call, management predicted Qdoba will have flat same-store sales for the remainder of FY 2013. In a growing fast-casual market, that isn’t great news. EPS is also somewhat concerning, as $1.26 per share for FY 2010 grew only marginally to $1.29 for the trailing twelve months, while EPS of $.30 for Q2 of 2013 was significantly less than the $.48 reported for Q2 of 2012. Management notes that, when restructuring and franchising costs are removed, EPS actually grew from $.30 in Q2 of 2012 to $.33 in Q2 of 2013, so this partially offsets my concerns.

The P/E of 24.9 makes this the cheapest chain of the three – but given concerns with same-store comps and the flat EPS, I’m not as confident in this investment paying off. Management blames their recently reported drop in Qdoba’s margins and same-store sales on weather, which may be a legitimate reason. However, I would wait to invest until we see whether Qdoba can bounce back from those losses for the remainder of the year. Since we are considering the company (and not just the Qdoba concept), observe how the refranchising strategy for the Jack in the Box concept affects EPS and margins before buying shares.

Final thoughts

My investing style is on the more conservative side – I prefer companies who have proven their ability to grow margins and post meaningful increases in EPS and revenue, and I favor them even more if they are trading at a comparatively cheap P/E ratio. Chipotle isn’t cheap from a P/E standpoint, but the company has a great balance sheet, superb growth opportunity, and a business model that is improving sales, revenues, and EPS.

For the more adventurous investor, Fiesta Restaurant Group would be another excellent choice – but keep an eye on the debt and the P/E ratio, and watch for any lagging in same-store sales. Jack in the Box is a potentially stronger chain for a value investor and still has opportunities for growth, particularly with the Qdoba brand, but I am less confident in its prospects and would not recommend buying it.

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Michael Douglass has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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