Over the years, food and beverage companies have expanded their network and have also experimented with their menu and marketing policies for driving more traffic. Chipotle Mexican Grill (CMG) and Yum! Brands (YUM) are among those quick service restaurants that have expanded their network on a global basis. Yum! Brands operate a series of brands like KFC, Taco Bell and Pizza Hutt.
Rise in prices of ingredients have hit the profit margins of restaurants. Commercial beef production (refer the chart below) is declining and this has led to a rise in beef prices.
The price hike is certainly affecting beef sales, which are declining for Chipotle and Taco Bell. The price hike of beef is also affecting the profit margin of the restaurants. The out of stock displays are commonly noticed at various nationwide chains of Chipotle.
Chipotle's solid performance
Chipotle Mexican Grill is one of the fastest growing restaurant chains in the U.S. The company records over $3billion in annual sales with around 1,500 chains spread across various locations. Over a span of 20 years, Chipotle has established a landmark in the restaurant industry. Chipotle has been successful in redefining the fast food concept by offering simple food with a motto of "food with integrity." Chipotle's pride is the fresh ingredients which it claims to be free from antibiotics.
The stock price of the company has seen a growth of over 600% in the past five years. The area of concern for the company is its profit margin that is not rising in tandem with its stock price. Profit margins have been declining as its year over year margin declined by 1.05% while the stock is becoming expensive with a trailing P/E of 46.
Can it continue growing?
It's not just the beef but the salsa ingredient costs, dairy products, and poultry products that are also seeing price increases. Rising marketing costs and competition are creating further pressure on Chipotle's margins.
Recently, Chipotle tailored its pinto beans menu by dropping pork and sticking with a vegetarian menu nationwide. This strategic move can leverage the rise in margin, as despite removing pork, it is charging the same price. Chipotle is also bolstering its portfolio with La Combe to serve coffee brewed from organic beans.
Currently, Chipotle is serving coffee as breakfast at two airports ((Dulles Airport & Baltimore-Washington International Airport). Chipotle can face fierce competition in coffee from fast food restaurants like McDonald's (MCD), Starbucks (SBUX) and Dunkin' Donuts (DNKN). Although Chipotle does not have any plans to serve coffee at all its locations, the possibilities cannot be ruled out. Coffee is one of the most popular beverages around the world with an annual consumption of 400 billion cups.
Clearly, the market for coffee is gigantic. These statistics reveal why Chipotle might serve coffee at all its locations in the U.S.
Total Coffee Drinkers in the U.S
Total Number of people that go to Premium outlets
Total Number of people that go to Economical outlets
Average cost of brewed coffee
Coffee constitutes 83.3% of the total hot beverages market in the U.S. Coffee consumption is predicted to increase at an annual growth rate of 2.7% till 2015. If Chipotle plans to serve coffee at all it outlets, a growth in revenue is highly possible.
A look at competition
Yum! Brands is another name in the restaurant industry that offers stringent competition to Chipotle through Taco Bell. Just like Chipotle, Taco Bell has also been restructuring it menu. Last year, the company joined hands with Lorena Garcia to evolve menu items like Cantina Burrito bowl and Cantina Burrito.
The price war between Taco Bell and Chipotle continues and Taco Bell offers Burritos for $5, which is around $1.50 less than similar servings by Chipotle. Despite this competitive price, Chipotle feels that it has loyal customers and its experience with Chipotle will keep bringing them back to its restaurants.
Yum!, on the other hand, is focusing on China. China is one of the biggest overseas markets with around 3,800 KFC restaurants. The decline of KFC was partly offset by the rise in sales reported by Pizza Hut. Yum! Brands KFC, on the other hand, is facing sales issues in China due to the bird flu hangover. In July, it had reported a sales drop of 13% since the start of the year and August was even worse at 16%.
Both Chipotle and Yum! Ply their trade in the same industry and both of them face the same problems such as price hikes of ingredients, which is affecting their margins. Strategic measures are being taken by both to increase margins as discussed above.
However, Chipotle's loyal customer base and the fact that analysts expect the company to grow at a superior rate in the future are points that should be taken into consideration. Chipotle trades at 46x trailing P/E, which is expensive. But the forward P/E comes down substantially to 34x means that considerable earnings growth is expected. It is expected that Chipotle will grow earnings at a CAGR of 20% over the next five years and this is really impressive.
Yum!'s earnings, on the other hand, are expected to grow at a CAGR of just 11% over the next five years, which makes the company's P/E ratio of almost 28 look expensive. Also, given the problems Yum! Is facing in China, Chipotle might prove to be a better pick.