Should investors take a bite out of these food stocks?

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In this article, I want to review McDonald’s (NYSE: MCD) and Chipotle Mexican Grill (New York Stock Exchange: CMG), which in addition to having some of the strongest brands in the space, their investment case is a key difference. McDonald’s is likely to be valued more by conservative income-oriented investors, while shares of Chipotle Mexican Grill may be more attractive to growth investors. I believe that both companies can cater to each class of investors quite adequately.

The QSR (Quick Service Restaurant) industry has been quite an interesting one to follow over the past few years. While the COVID-19 pandemic has negatively impacted sit-in-oriented restaurants, quick-service ones have continued to operate steadily as they shift heavily to food deliveries.

Nevertheless, I remain cautious vis-à-vis the industry in an environment of rising rates which could notably affect consumer purchasing power and therefore QSR spending. In this scenario, their lofty valuations could be squeezed. Accordingly, I am neutral on both names.

With McDonald’s having an incredibly established presence and a proven investment record, the stock has held firm 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 safety margin (for example, it doesn’t even pay a dividend), but investors appreciate its much more impressive earnings growth prospects. Let’s examine:

McDonald’s

Investors should consider McDonald’s over Chipotle for its considerably higher reliability. Approximately 95% of the company’s total locations are franchised, and this is where McDonald’s business model provides a significantly higher margin of safety. Essentially, McDonald’s often owns the real estate where its franchisees operate their restaurants. As a result, the company generates most of its cash flow from the rent and royalties that its franchisees pay.

As a result, McDonald’s isn’t really involved in the general hassle needed to actually run most of its locations. As a result, McDonald’s enjoys frictionless, high-margin cash flow.

These characteristics, combined with McDonald’s outstanding track record of capital return and shareholder value creation, make the stock an excellent destination for income-oriented investors in uncertain times such as today. Specifically, with 46 consecutive years the dividend increasesMcDonald’s has proven that its lean business model can generate resilient results and deliver growing payouts to investors in various economic environments, including recessions.

Is McDonald’s stock a buy or a sell?

As far as Wall Street is concerned, McDonald’s has a strong buy consensus rating based on 22 buys and four takes awarded over the past three months. At $282.09, the average forecast for McDonald’s shares points to 22.3% upside potential.

Chipotle Mexican Grill

Chipotle may not have McDonald’s impressive track record of return on capital and overall reliability that comes with maturity, but it seems to offer much more promising growth prospects. The company is in the midst of store openings, which translates into revenue growth, economic evolution and skyrocketing net income growth.

Specifically, while the company’s 5-year revenue growth CAGR stands at a respectable 11.6%, its 5-year net revenue growth CAGR stands at a much more impressive 40, 8%. Indeed, by opening more restaurants and improving operational efficiencies between them, it has resulted in solid margin expansion on top of underlying revenue growth. In fact, the company’s EBITDA margin fell from 5.25% in 2017 to 14.4% last year.

This trend was once again relevant in the company’s latest quarterly results, as the company opened 42 new restaurants in 32 locations, including a Chipotlane. In addition to these new restaurants contributing to turnover, the 17% revenue growth to $2.2 billion was mainly driven by the 10.1% increase in same-store restaurant sales.

With operating efficiencies amid economies of scale, Chipotle’s restaurant-level operating margin was 25.2%, up 70 basis points year-on-year on the other. Thus, the company’s operating margin stood at 15.3%, up from 13.0% last year, continuing the underlying trend of recent years.

Is CMG stock a buy?

Chipotle Mexican Grill also has a Strong Buy Consensus Rating based on 21 purchases and three assigned reservations over the past three months. At $1,817.95, the average forecast for CMG shares implies an equally attractive upside potential of 21%.

Key Takeaway: Beware of MCD and CMG Stock Valuations

In my opinion, McDonald’s and Chipotle Mexican Grill are quality businesses that can prove to be successful investments for investors, each catering to different investment preferences. That said, since both companies offer very strong characteristics in their respective value creation pathways, both are trading at a noticeable premium.

McDonald’s is currently trading at around 24 times projected earnings this year, which is a high multiple given that the company is not expected to grow north of the average numbers. Chipotle Mexican Grill is trading at an even steeper forward P/E of 47, and while earnings per share are expected to grow more than 20% over the next few years, the multiple provides a very small margin of safety in today’s market. . environment.

As a result, investors should be wary of the price they are paying for these two QSR giants despite their compelling features.

Disclosure

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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