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The David Einhorn Taste Test

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

Normally, we end these blog posts with disclosures, but I'll start with one: I'm a David Einhorn fan. I'm not sure how any literate person or cognizant observer of the market wouldn't be after reading his book, Fooling Some of the People All of the Time. Unless, of course, he or she worked for Allied Capital or the U.S. Securities and Exchange Commission.

But you'll have to read the book to get the details on that.

I might be a tad over enthused at times, so after reading his book I called his hedge fund, Greenlight Capital, to see if he'd be interested in taking me on as an admittedly minor investment partner. The conversation was going swell until the nice lady who keeps the gate mentioned the minimum initial investment of $1 million. Alas, most of my liquid reserves were overseas at the time and I could not repatriate them without onerous tax consequences. You understand.

As a proxy, I scoured the sofa for spare change and picked up a few shares of his reinsurance vehicle, Greenlight Capital Re, which I hold to this day so I can get the benefit of his various calls, whether he's short Green Mountain Coffee Roasters  and Chipotle Mexican Grill (NYSE: CMG), or long General Motors and Cigna.

For that matter, I was hoping Einhorn would end up with control of the New York Mets, but it appears that Fred Wilpon managed to escape his Bernie Madoff entanglement without having to cash out of his perpetually disappointing baseball club.

In any case, when Einhorn declared at the recent Value Investing Conference that Taco Bell's new Cantina Bell menu represented a challenge to Chipotle, and was part of his rationale for shorting Chipotle, I was a little surprised.

First, it was hard to imagine that Einhorn had actually tried the Cantina Bell menu. In fact, it was hard to imagine Einhorn ever setting foot in a Taco Bell. I mean, if you were a billionaire, would you?

Second, his claim that a survey showed 75% of Chipotle customers also patronize Taco Bell sounded decidedly unscientific. Your economic fortunes might drive you from one to the other, but I know of very few people who flip a coin to decide which one to patronize when they have a choice.

Third, due in part to my aforementioned liquidity issues, I have liberally sampled the fare of both companies at various times over the years, and I can report that Taco Bell has two and only two advantages over Chipotle: it's cheaper and it's open later.

But having an open mind is a prerequisite to impartial analysis, which is why I decided to conduct my own taste test. I purchased a chicken Cantina Bowl from Taco Bell and a chicken burrito bowl from Chipotle, both to go. I bought them as cheaply as I could -- no extras -- which meant I ended up with guacamole on the Cantina Bowl but not the burrito bowl.

Cost comparison: $6.75 for Chipotle, $5.17 for Taco Bell. (Why, exactly, do fast food places always leave you with a pocket full of change? Do they know nobody uses change anymore?)

Here's what they looked like (the Cantina Bowl is on top):

The Taco Bell ad campaign for the Cantina Bell menu features chef Lorena Garcia and is very impressive. Indeed, the ingredients in the marketing campaign sound very much like Chipotle's -- "citrus-herb marinated chicken, flavorful black beans, guacamole made from real Hass avocados, roasted corn & pepper salsa, a creamy cilantro dressing, and freshly prepared pico de gallo, all served on a bed of cilantro rice."

In theory, it should have provided a wider variety of flavors than my bare-bones Chipotle burrito bowl, which included only rice, black beans, chicken, tomato salsa and lettuce.

The main difference was that everything in the Cantina Bowl was soggy, so the flavors all sort of mushed together. I blame that "creamy cilantro sauce." I don't know if the Cantina Bowl is available without it.

Even without the dressing, Taco Bell lettuce tends toward the limp, sitting in its bin all day in some locations, while Chipotle's is fresh and crisp. The tomatoes differ similarly.

Each ingredient in the Chipotle bowl had its own distinct flavor. It was plain the way I dressed it, but it tasted like real food. And it was still spicier than the Cantina Bowl, which tasted like a very diligent attempt by Commander Spock to simulate what human food tastes like. Next time, I suggest maple syrup.

So my first instinct was to pan Einhorn's comparison of the dishes as the conjecture of someone who had probably never eaten either one. That was before YUM! Brands (NYSE: YUM) came out with earnings last week. It's well-known that much of YUM!'s growth is coming from China -- and most of that from KFC -- but the company also reported stronger-than-expected U.S. comparable store sales in Q3, with the new Cantina menu representing a reported 5% of sales.

Meanwhile, Chipotle's shares tanked in July when it reported weaker-than-expected comparable store sales starting just about the time Taco Bell introduced the Cantina Bell. Interestingly enough, Taco Bell's U.S. comparable store sales increased 6% in the third quarter, leading to investor enthusiasm; meanwhile Chipotle's increased 8% in the second quarter, leading to investor flight.

Why? Well, for one thing, YUM! also has its Chinese growth engine, something Chipotle doesn't have. For another, even after its crash from over $400 a share last spring to just under $300 now, Chipotle still trades at 35 times trailing earnings. With analysts predicting annual growth over the next five years in the 20% range, that's expensive.

And YUM!, even after a run-up from $66 to $71 per share following its third quarter report, trades at about 21 times trailing earnings. YUM is a much bigger company ($32 billion market cap compared to Chipotle's $9 billion), so analysts expect it to grow more slowly, at an annual rate of about 13%, meaning its share price isn't much more of a bargain than Chipotle's. However, YUM! pays a growing dividend (now nearly 2%), while Chipotle redirects its cash flow into new stores.

You'll note that Einhorn did not publicly advocate going long YUM! while he was publicly advocating shorting Chipotle. YUM! may still be a good investment at these prices, but it's not exactly a bargain for the value investor. Chipotle is a terrific restaurant chain, but its hypergrowth phase is probably over. Unless it's getting ready to take over the world in the manner of its parent, McDonald's, a lot of future growth is already priced in. McDonald's sells for half the earnings multiple and offers a dividend in excess of 3%.

If you're looking for the better burrito bowl, I'd spring for the extra couple of bucks and buy Chipotle's. Aside from everything else, the difference in the attitude of the people working behind the counter is generally worth it. But if you're looking for an undervalued quick-serve Mexican food restaurant chain, I'd keep looking.


ultimatespinach owns shares of Greenlight Capital. The Motley Fool owns shares of Chipotle Mexican Grill and has the following options: long DEC 2012 $16.00 puts on Green Mountain Coffee Roasters and short DEC 2012 $21.00 calls on Green Mountain Coffee Roasters. Motley Fool newsletter services recommend Chipotle Mexican Grill, General Motors Company, and Green Mountain Coffee Roasters. 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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