Jack in the Box: The Poor Man’s Chipotle
Shawn is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
There has been a great deal of debate recently on the valuation of Chipotle (NYSE: CMG) given its meteoric rise over the past few years. Does the company serve fantastic food? Absolutely. Should it be valued at 61 times current earnings? I am not sure. But investors who want a piece of the casual Mexican taco should take a look at much more reasonably priced Jack in the Box (NASDAQ: JACK). Not because of the company's legacy hamburger business or creepy mascot but because of Jack’s Qdoba Mexican Grill subsidiary.
Qdoba Mexican Grill has 262 company owned and 335 franchised locations (for purposes of comparing the two companies, I am only going to discuss the company owned stores going forward as Chipotle does not have any franchise locations.) Jack is similar to Chipotle in that they both serve fast casual Mexican food but is much less profitable on a per unit basis.
Most investors would shy away from the company given the profit disparity but if you examine the items that make Qdoba less profitable, I would argue that the company has room for improvement. Examining the cost disparities further, the main difference in unit costs stem from differences in labor and occupancy costs.
Let’s first examine occupancy costs. Chipotle learned a long time again that a worthwhile strategy in serving the casual food market is to target high density areas like cities and college campuses as these consumers order takeout more than in non-dense areas. This benefits the company by not requiring a large space to accommodate more consumers wishing to dine in. Shifting towards a smaller design is part of the reason Chipotle has been able to lower costs 160 basis points or $36 million in the past few years. Qdoba on the other hand, targets consumers in less dense areas with more spacious stores. Qdoba could learn from their counterpart and design stores to be smaller and more efficient. If the company could realize the same occupancy costs as their counterpart, shareholders would benefit with almost $19 million, or $0.47 per share in savings.
Labor costs are not surprisingly a factor of how large the restaurant is given the need for more staff to maintain the restaurant. Therefore Qdoba’s larger units inherently require higher labor costs. After a brief stint of strategy hiring additional workers to help throughput and customer satisfaction, the company has decided to focus on increasing worker productivity. Some actions the company could undertake are better employee training and redesigning the kitchen to allow for greater throughput. If the company was to match Chipotle in labor costs, shareholders would benefit with $8 million in savings.
Spin-off could be necessary
Even if Qdoba was able to lower costs as I noted above, the impact on the stock price would be less than they would be if it was a standalone company. Why? Because the company’s operations get buried by the larger hamburger joint that is the company’s namesake. In a market where a direct competitor is trading at five times your book value, management should unlock some value to shareholders and spin off Qdoba. If the standalone company was valued at the same 30 times Enterprise Value/EBITDA that CMG is valued at, the company would have a market value of $700 million or almost 70% of the market cap of their parent company. That should be too tempting for management to pass up.
Do you believe Jack in the Box is a buy? Will management spin off Qdoba? Share your comments below!
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