These Restaurant Stocks are Great for a Nibble

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

Google the latest financial news and I would not be surprised if you encounter articles discussing the impending stock market collapse due to the upcoming Fiscal Cliff, a slow-down in China’s growth story, or the nerve-wracking economic malaise in Europe. Such news would understandably make any investor nervous. However, amidst that back-drop it is easy to forget that there are still great businesses whose goods and services are in huge demand and will still be in demand many years down the road. Being a part owner of these great businesses through thick and thin over the years has been one of the best ways to build meaningful wealth, and should still remain true even as we head into the second decade of the 21st century.

Should you not take my word for it, at least take heed from the inimitable Warren Buffett, who wrote a particularly succinct sentence of what investing is to him in his 1996 Berkshire Hathaway Annual Report - “Your goal as an investor should be simply to purchase, at a rational price, a part interest in an easily understood business whose earnings are virtually certain to be materially higher, five, ten, and twenty years from now.’’ It sounds simple, but is by no means an easy feat to accomplish.  How then, can we try to apply these principles in our own investing activities? Fortunately, there are great restaurant companies in the US where we can use the 1) Rational Price, 2) Easily Understandable Business and 3) Virtually certain material increase in earnings framework as a guide for our investing activities.

Chipotle Mexican Grill (NYSE: CMG) and Panera Bread (NASDAQ: PNRA) have been great investments so far over the past six years, returning 324.8% and 160.4%, respectively, from Nov. 19 2006 to Nov. 19 2012. Bear in mind that we had one of the worst financial crises in 2008-2009 with the ensuing stock market collapse, so the returns from these two stocks look all the more remarkable.

Back in November 2006, Chipotle was trading at a Trailing-Twelve-Month (TTM) P/E of about 45. That is a rich valuation and would not normally be considered a reasonable price. However, if we looked at its business, it would not be hard to understand. Chipotle operates fast-casual restaurants that serve Mexican-styled food. They grow their business by improving sales in existing restaurants (also known as Comparable Store Sales, or Comps), as well as disciplined expansion of about 100 restaurants per year. With the added revenue streams from new restaurants, Comps that averaged 11.75% in FY 2004 and FY 2005, as well as improving operating margins from 4.94% to 7.55%, the chances of Chipotle having materially higher earnings 5 years down the road was really high. Chipotle’s strong balance sheet at that time ($157 million in cash and no debt) also helped strengthen its investment thesis.

Fast forward 6 years later to Nov. 2012 and we find that Chipotle’s TTM revenue and earnings have increased from $776 million and $35 million to $2.63 billion and $274 million, respectively. Their restaurant store count has increased from 547 to 1350, while their balance sheet has also improved such that they are carrying $733 million in cash with no debt. Average Comps from FY 2006 to FY 2011 stand at a very healthy growth of 8.85%. After a 324.8% increase in its stock price and a 338% increase in its revenue over the past 6 years, the key question is: can Chipotle Mexican Grill still be a winning investment from this point on? Let’s analyze the current Chipotle Mexican Grill using the framework discussed earlier, and we shall see why I am confident that Chipotle Mexican Grill can still be a great investment 5 to 10 years down the road.

Chipotle currently trades at $267 per share with a TTM P/E of 31. Again, by looking at the P/E of Chipotle in isolation, its valuation might seem high at first glance. But given its 22.6% and 41.6% compounded annual growth rate (CAGR) in revenue and earnings, respectively, over the past 6 years, a current TTM P/E of 31 does not seem that expensive, and hence fulfills the criteria for a reasonable price. Sure, Chipotle will not be able to sustain its phenomenal revenue and earnings growth as it builds upon a much larger store base while management remains insistent on disciplined expansion. However, Chipotle looks to be able to achieve material increases in their earnings five, ten, and twenty years from now with a very high probability (more on that later).

Moving on to Chipotle’s business, they still open and operate fast-casual restaurants that serve Mexican-style food. They have added 4 restaurants that operate with an Asian-food theme, but the basic business-operating concept remains unchanged. They are and will likely remain an easily understandable business.

Chipotle started out as a purely domestic business, but has since opened restaurants in Canada, England, and France. Domestically, analysts believe that Chipotle can build up to 3,500 restaurants, while their international growth story has just started with only 10 restaurants opened so far overseas. This creates a lot of potential for Chipotle to have much higher earnings five, ten, or even twenty years down the road. As they now open about 150 new restaurants per year, it will take a long time for them to reach saturation point. We only have to compare McDonalds' (NYSE: MCD) 33,000 restaurants to have a rough gauge on how big Chipotle might get. Thus, it would not be hard to imagine a situation many years into the future in which Chipotle has materially higher earnings.

The story going forward with Panera Bread is essentially similar to Chipotle. Panera is a purely domestic operation and they now operate 1,625 bakery-cafes across the US. At a current TTM P/E of 30, with historical revenue and earnings CAGRs of 17.8% and 19.1%, respectively, over the past 6 years, Panera is definitely not in bargain territory. However, it can be argued that it is actually a reasonable price to pay due to their consistent high-quality growth in revenue and earnings over the years. Their pristine balance sheet, with $290 million in cash and no debt, also makes it easy to pay up a little for Panera. Its business is also easily understood – they try and improve sales in existing restaurants while opening about 70 new restaurants per year.

There is also a great growth hook ahead for Panera as they are estimated to be able to open up to 4,000 restaurants by analysts. This once again bodes well for the possibility of seeing much higher earnings for Panera in the future, a situation much akin to Chipotle, as discussed earlier. Once again, the framework of 1) Rational Price, 2) Easily Understandable Business and 3) Virtually certain material increase in earnings has been used as a guide to evaluate Panera, and the company would probably be a winning investment five to ten years down the road.

My line of reasoning for the investment merits of these two restaurant stocks might seem overly simple and naïve, but there is a beauty in keeping things simple. If there is one thing that my time as a subscriber to the Motley Fool’s services has taught me, it is that investing is not as scary or complicated as Wall Street or the ‘’professionals’’ would like us to believe. Purchase, at a rational price, a part interest in an easily understood business whose earnings are virtually certain to be materially higher, five, ten, and twenty years from now – there really is beauty in simplicity.

 


serjing owns shares of Panera Bread and Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill, McDonald's, and Panera Bread. Motley Fool newsletter services recommend Chipotle Mexican Grill, McDonald's, and Panera Bread. 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!

blog comments powered by Disqus