Domino's and Chipotle: The Future of Fast Food

Includes: CMG, DPZ
by: Spencer Knight

When it comes to food companies, marketing and appeal are two of the best traits. While a restaurant may have good food, if the company cannot get customers in the door, the restaurant will fail. Two companies that have good food and strong marketing campaigns are Domino's Pizza (NYSE:DPZ) and Chipotle Mexican Grill (NYSE:CMG).

On the one hand Domino's has began using fresher ingredients, new recipes, and allowing customers to publicly share their thoughts about the food. On the other hand, Chipotle has branded the company has a fresh ingredient and recycling and reusing powerhouse. The important question is which stock is the better buy? Should investors order Domino's to go or sit in at Chipotle for the long term?

To begin I will discuss parts of the financial reports of each company since the two companies went public. When comparing food companies the most important numbers to consider are costs and net income. Chipotle has had seen costs increase by 179.8% and net income by 540.5% since the first quarter of 2006. While Domino's has only seen costs increase by 11.2% and net income by about 59.5% since 2004. Therefore over the course of each respective companies public lifetime, Chipotle has nearly doubled Domino's in terms of the ratio of costs to net income. These numbers, among other things, explain why Domino"s share price has not been able to explode in the manner Chipotle has over the past seven years. The graphs below show the rise in net income from both companies.

Other important factors when considering a strong company is revenue and earnings per share (EPS). These are important because revenue can dictate how much customer base a company has; while EPS, which is related to net income, can explain how much of the companies revenue is going towards investors. In terms of revenue Chipotle has more or less been able to produce a continuous stream of higher income every quarter since the first quarter of 2006. The exceptions to this are very miniscule and not significant. Nevertheless, from the second to third quarter of 2008 and 2009 we see revenue slip slightly.
Chipotle Mexican Grill
Year Quarter Revenue EPS Costs
2 571.5 1.59 487.7
2011 1 509.3 1.46 434.5
4 482.5 1.47 408.6
3 476.8 1.52 399.3
2 466.8 1.46 391.8
2010 1 409.6 1.19 348.4
4 387.5 0.99 337.3
3 387.5 1.08 332.7
2 388.8 1.10 331.5
2009 1 354.4 0.78 313.2
4 345.3 0.51 317.6
3 340.5 0.59 309.4
2 340.6 0.74 302.4
2008 1 305.3 0.52 278.5
4 289 0.53 261.6
3 286.4 0.62 255
2 274.3 0.60 243.6
2007 1 236 0.38 217.4
4 219.8 0.33 204.2
3 211.2 0.36 193.4
2 204.9 0.33 189
2006 1 187 0.26 174.3

(All above numbers are in millions of dollars, except earnings per share)

On the other hand Domino's has not been able to set record revenue highs quarter over quarter. In fact prior to the fourth quarter of 2010, Domino's best quarter in terms of revenue was the fourth quarter of 2004. It is important to note Domino's earnings follow a consistent pattern. For instance the fourth quarter is always the strongest quarter. Also, with only one extremely minor exception, the third quarter is the companies weakest quarter. One plausible explanation for this can be the Summer. The Summer may cause this slip because college students are not in school and commodity prices are generally higher during the months of July-September. Knowing this pattern can help investors prepare for a slower quarter this current quarter and followed by an exceptional quarter at the end of 2011.

Domino's Pizza
Year Quarter Revenue EPS Costs
2 384.9 0.40 274.2
2011 1 389.2 0.42 277.6
4 479.9 0.40 343.8
3 347.4 0.27 253.2
2 362.4 0.33 262.1
2010 1 381.1 0.35 273.1
4 462.8 0.30 333.2
3 302.7 0.17 219.5
2 316.6 0.21 230.6
2009 1 321.8 0.20 233
4 428.2 0.19 319.4
3 323.6 0.13 244.8
2 334.3 0.22 246.6
2008 1 339 0.21 250.9
4 445.9 0.21 333.9
3 337.3 0.17 253.9
2 340.3 0.28 248,4
2007 1 339.3 0.38 248.2
4 435.3 0.49 319.5
3 326.7 0.34 240.9
2 327.7 0.34 238.9
2006 1 347.7 0.39 253.3
4 457.4 0.45 340
3 337.5 0.30 251
2 346.9 0.35 258.5
2005 1 369.6 0.35 276.6
4 478.5 0.38 362.8
3 324.9 0.23 245.7
2004 2 324 0.18 246.6

(All above numbers are in million of dollars, except earnings per share)

Now we can discuss the lifetime charts of each stock. Based upon the earnings of either company, one can imagine Chipotle's stock has faired several times better than Domino's. Chipotle's stock has indeed outgained Domino's in several aspects; with a few recent exceptions. The periods Domino's stock has outperformed Chipotle is year to date in 2011 and over the past six months. By viewing the year to date chart you can see Domino's has returned about 53.8% while Chipotle has returned 35.5%. Similarly over the past six months Domino's has outperformed Chipotle 50.5% to 20% respectively.

(Year to date chart comparing DPZ to CMG)
This brings us to the question of can Domino's surpass Chipotle's stock performance in the future? One of the key aspects to this question is the present. While Chipotle's stock nearly doubled the return of Domino's prior to the 2008 bottom; Domino's stock has powered back in ways investors take for granted. Since the bottom in November 2008 Domino's stock has nearly matched Chipotle's stock. Chipotle has returned an 654% in less than three years while Domino's has returned 650%. This shows Domino's may be very close to breaking out of the shadow of Chipotle.

However it must be noted Domino's does have debt that needs to be paid off before jumping into the stock as a retirement holding. The company currently has about $1.45 billion in debt on the balance sheet. This is an extreme amount of debt for a company that is only bringing in roughly $105-$120 million per year. However witty, and risky, investors can use this debt to their advantage. For instance if Domino's can pay off the debt in a reasonable manner that does not provoke long term problems, we should see the stock price pop as investors see J. Patrick Doyle, Domino's CEO, has the company moving in the right long term direction. In fact if not for the debt holding Domino's stock back, the share price may be at the 50-60 level right now.
This leads us to whether or not Domino's should replace Chipotle in your portfolio. I cannot give a definitive answer because it depends what kind of investor you are. If you are looking for a strong long term company Chipotle is the better stock. However if you are looking for a speculative play with great potential and protection from a downside slide, Domino's is the stock to buy.
Keep in mind when the market crashed in 2008, Domino's only dropped 58% compared to Chipotle's 74% slide. Also keep in mind Chipotle has virtually no debt; which is why the stock has a P/E ratio three times higher than Domino's. Since investors are not willing to invest in Domino's while the company has such a high amount of debt, therefore the stock trades pretty close to actual earnings. In fact if Domino's had the same P/E as Chipotle, the stock would be over 70; which is higher than my 50-60 expectation if the company did not have $1.45 billion in debt.

Disclosure: Author is long DPZ.