Buying Jack In The Box Over Chipotle Is A Good Play

Includes: CMG, JACK
by: Benjamin Goldman

Like most people in their twenties, I am a big fan of burritos. Burrito bars have become very popular over the past few years, as their service times are similar to those of fast food restaurants while the food quality is higher. Personally my favorite burrito chain is Qdoba, which is owned by Jack in the Box (NASDAQ:JACK). Chipotle is the market’s favorite burrito chain, as it is the most valuable of the burrito chains and has over 1,000 locations, compared to Qdoba which has about 560 locations. In this article, I analyze Chipotle and Qdoba stock and provide insight for investors

There are several reasons why I prefer Qdoba to Chipotle. Qdoba has similar quality to Chipotle, but offers a wider selection and is cheaper. From a variety standpoint, Qdoba has queso, gumbo and other menu offerings that Chipotle does not have. However, my personal opinion of one burrito bar being better than another does not fully justify an investment.

What has made Chipotle more valuable than Qdoba is its guidance from McDonald’s (NYSE:MCD). McDonald's used to be the largest shareholder in Chipotle, allowing it to grow rapidly. Ever since McDonald's fully divested from Chipotle in October 2006, it has continued to grow rapidly. Chipotle’s fewer ingredients make it easier for Chipotle to manage its inventory and streamline its production, which increases income from reduced service time and lower costs in inventory management. Chipotle can offer queso sauce if it really wanted to, but management chooses not to because it would make the burrito bar more complex and hurt efficiency. Ownership by McDonald’s also gave Chipotle the necessary capital to quickly expand. McDonald’s is a very profitable chain and has room to grow, while Jack in the Box currently closes more stores than it opens. This advantage allowed Chipotle to have a larger market presence much faster than Qdoba.

Companies are ultimately valued by their earnings. Chipotle’s subtle moves that allow it to be more profitable than Qdoba are what make it so much more valuable in the current market. Chipotle’s high market value is also derived from its high valuation, as investors believe that it will sustain high growth over the next few years. Chipotle’s high relative value to Jack in the Box is similar to that of Netflix’s (NASDAQ:NFLX) high relative value to Coinstar (NASDAQ:CSTR), the owner of Redbox. In recent performance, Chipotle has outperformed the market from its expectations to strongly beat competitors in growth and profit margins. Its stock increased by 8.31 percent on October 21st as Chipotle continues to justify its stock’s P/E ratio of 52. However, some analysts believe that Chipotle shares will dive as time moves on. If it doesn’t continue to meet its high expected growth or if more competitors enter the market, shares could take a haircut as high as 50 percent. Jack in the Box shares have been underperforming the market, dropping by 15.3 percent over the past three months. For those who want to hop on board the Qdoba bandwagon, now is the time.

Because of its high earnings multiple and its potential to substantially fall in value, I place a HOLD recommendation on Chopotle. Even though Jack in the Box seems like it is a much better value and is a steal in the current market, I only put a soft Buy on JACK for a few reasons. For Qdoba to realize earnings that are high enough to trigger a substantial price increase, it would have to be bought out by a restaurant business with the capital to accelerate Qdoba’s growth. I do not believe that Jack in the Box has the necessary management abilities to make Qdoba a more prominent burrito bar than Chipotle, and I do not believe that the company intends to sell Qdoba anytime soon. I do like the fast food industry as a whole because the majority of it-- including McDonald’s and Yum! Brands-- has been performing quite well, and I believe they will continue to outperform the market in the event of a recession.

Note: For those wondering where Moe’s Southwestern Grill stands in this conversation, it is owned by FOCUS Brands, a privately equity firms that owns a few other chains including Carvel and Cinnabon. There are currently about 400 restaurants in the Moe’s franchise.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.