In this piece, I want to go over McDonald’s (NYSE: MCD) and Chipotle Mexican Grill (NYSE: CMG), which besides having some of the strongest brands in the space, their investment cases pose a key difference. McDonald’s is likely to be appreciated more by conservative, income-oriented investors, while shares of Chipotle Mexican Grill may be more charming to growth investors. I believe that both companies can cater to each investor class rather adequately.
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The QSR (Quick Service Restaurant) industry has been quite interesting to pay attention to over the past few years. While the COVID-19 pandemic adversely impacted sit-in-oriented restaurants, the quick-service ones continued to operate firmly as they pivoted heavily toward food deliveries.
Still, I remain cautious of the industry in a rising-rates environment which could notably affect consumers’ purchasing power and thus spending on QSR. In that scenario, their elevated valuations could be compressed. Accordingly, I am neutral on both names.
With McDonald’s having an incredibly established presence and a well-demonstrated investment case, the stock has held its ground over the past year. This is likely to remain the case. Shares of Chipotle Mexican Grill have also outperformed the overall market over the past year. Sure, the stock doesn’t offer the same margin of safety (e.g., it doesn’t even pay a dividend), but investors appreciate its way more impressive earnings growth prospects. Let’s examine:
McDonald’s
Investors should consider McDonald’s over Chipotle for its considerably higher reliability. Roughly 95% of the company’s total locations are franchised, and this is where McDonald’s business model offers a considerably higher margin of safety. Essentially, McDonald’s often owns the real estate where its franchisees operate their restaurants. This results in the company generating the bulk of its cash flow from the rent and royalties its franchisees contribute.
As a result, McDonald’s is not really involved in the overall hassle needed to actually run most of its locations. Accordingly, McDonald’s enjoys frictionless and high-margin cash flows.
These traits, fused with McDonald’s outstanding track record of capital returns and shareholder value creation, result in the stock being an excellent destination for income-oriented investors during times of uncertainty like today. Specifically, with 46 years of consecutive dividend increases, McDonald’s has proven that its lean business model can generate resilient results and provide growing payouts to investors through various economic environments, including recessions.
Is McDonald’s Stock a Buy or Sell?
Turning to Wall Street, McDonald’s has a Strong Buy consensus rating based on 22 Buys and four Holds assigned in the past three months. At $282.09, the average McDonald’s stock forecast indicates a 22.3% upside potential.
Chipotle Mexican Grill
Chipotle may lack McDonald’s impressive track record of capital returns and overall trustworthiness that comes with maturity, but it appears to be offering much brighter growth prospects. The company is on a store-opening spree, resulting in growing revenues, scaling economics, and snowballing net income growth.
Specifically, while the company’s 5-year revenue growth CAGR stands at a respectable 11.6%, its 5-year net income growth CAGR stands at a much more impressive 40.8%. This is because by opening more restaurants and enhancing the operating efficiencies between them, it has driven a robust margin expansion on top of the underlying revenue growth. In fact, the company’s EBITDA margin expanded from 5.25% in 2017 to 14.4% last year.
This trend was relevant once again in the company’s most recent quarterly results, with the company opening 42 new restaurants in 32 locations, including a Chipotlane. Besides these new restaurants contributing to the top line, the 17% revenue growth to $2.2 billion was mainly driven by comparable restaurant sales rising 10.1%.
With operating efficiencies amid economies of scale kicking in, Chipotle’s restaurant-level operating margin came in at 25.2%, an increase of 70 basis points year-over-year. Thus, the company’s operating margin came in at 15.3%, an increase from 13.0% last year, continuing the underlying trend of the past few years.
Is CMG Stock a Buy?
Chipotle Mexican Grill also features a Strong Buy consensus rating based on 21 Buys and three Holds assigned in the past three months. At $1,817.95, the average CMG stock forecast implies an equally appealing 21% upside potential.
Takeaway: Be Wary of MCD and CMG Stocks’ Valuations
In my view, both McDonald’s and Chipotle Mexican Grill are quality companies that can turn out to be fruitful investments for investors, with each catering to different investment preferences. That said, due to both companies offering very solid characteristics in their respective value-creation pathways, both are trading at a notable premium.
McDonald’s is currently trading at around 24 times this year’s projected earnings, which is a steep multiple considering the company should not be growing north of the mid-single-digits. Chipotle Mexican Grill is trading at an even steeper forward P/E of 47, and while earnings-per-share is expected to expand well over 20% over the next few years, the multiple offers a very thin margin of safety during the current market environment.
Accordingly, investors should be wary of how much they are paying for these two QSR giants despite their compelling characteristics.
