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Which of These 3 Restaurants Should You Go For?

March 30, 2014 | About:
Vinay Singh

Vinay Singh

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The compound annual growth rate for limited-service restaurants is expected to be 4.5% from 2012 through 2017, while fast-casual operators are expected to grow at 10% on average over the same period. "Fast casual has become a $31 billion segment since Chipotle began reinventing fast food 20 years ago," said Darren Tristano, executive vice president of Technomic. This opens up a good opportunity for the likes of Chipotle Mexican Grill (CMG), Panera Bread (PNRA), and Buffalo Wild Wings (BWLD).

Chipotle's turnaround

Those who sold Chipotle in 2012 after two bad quarters at around $250 per share shouldn't be feeling too elated right now, as shares have soared past the $500 mark. This growth has been in tandem with the growth of fast-casual restaurants, which make up just 14% of the $223 billion limited-service restaurant industry.

Chipotle seems to have made good use of this opportunity. It has carved out a remarkable success story for itself since those bad quarters in 2012 that I mentioned earlier. On the back of strong traffic, its net sales surged 18% versus the same quarter last year to $826.9 million.

Sales were driven by new menu items. Among the new menu items, Chipotle added a new tofu-like product called "sofritas," which, at present, is being served at only 25% of its restaurants and is expected to be rolled out to 40% of its restaurants by the end of the year.

New menu items seem to be paying off, as they already account for 4% of sales at restaurants where they are being served. In addition to new menu items, marketing efforts are driving more traffic. This is evident from the way comps have increased from 1% in the first quarter to 5.5% in the second quarter and 6.2% in the current quarter.

However, Chipotle couldn't escape the industry-wide problem of rising commodity costs, which led to margin pressure. Operating margin was down 60 basis points, offset by a 40-basis point decrease in labor costs due to higher comps. In addition, Chipotle is using non-GMO supplies and promoting healthy eating habits, and these initiatives also led to an increase in input costs.

Buoyed by strong third-quarter results, Chipotle has increased its comps guidance for 2013. It expects comps to grow in mid single-digits, up from the previous estimate of low-to-mid single digits. The GMO-free initiative should lead to good results going forward as consumers become conscious about healthy eating. In addition, new menu items should also lead to more sales.

Opportunity in Panera

If you think that you'd missed an opportunity by selling Chipotle, it looks like another opportunity has opened up recently. Panera Bread has struggled of late, but seems to be in a similar position as that of Chipotle in the third quarter of 2012.

Panera has posted tepid results in the past few quarters. It reported a decline in comps in the previous quarter, missing analysts' expectations on revenue despite 8% growth in revenue from the year ago quarter. Panera had also reduced its guidance for the ongoing quarter.

However, Panera is the leader in the bakery cafe space of the fast-casual segment. All is not over for the company; I think that Panera will rebound just like Chipotle did after that bad phase in 2012. Panera is firmly positioned in one of the best growth industries in America -- fast casual.

Also, Panera intends to hire more employees and streamline its menu. This could prove to be a good strategy since Chipotle has been following a similar path. A restructuring of the menu could help Panera serve better food and keep costs under control. The company is also undertaking other initiatives such as installing kitchen-display systems to improve the accuracy of orders placed. Such moves should enhance customer experience and help Panera perform better.

Buffalo's wild growth

Like Chipotle, Buffalo Wild Wings has also been reporting solid growth rates of late. It posted an increase of 27.9% in revenue during the third quarter, while earnings per share grew an impressive 65.4% versus the year-ago period. It also reported a comps increase of 4.8% at company-owned restaurants and 3.9% at franchised restaurants during the quarter.

Buffalo Wild Wings currently has 951 restaurants, and management estimates the potential for around 1,700 restaurants in the U.S. and Canada. This translates into a huge growth opportunity going forward. Buffalo Wild Wings is also foraying into other areas; the company made a minority interest investment in PizzaRev and is planning to open the first company-owned PizzaRev in the Minneapolis area in early 2014.

Analysts are expecting good earnings growth at Buffalo Wild Wings. Its five-year earnings compound annual growth rate is 18.5%, which is slightly lower than Chipotle's 21.4%. However, Buffalo Wild Wings is cheaper than Chipotle on a trailing P/E basis. Buffalo Wild Wings' P/E is 41, while Chipotle trades at 54.71. Hence, those looking for a slightly cheaper option in the fast casual space could look at Buffalo Wild Wings.

Bottom line

Chipotle and Buffalo Wild Wings have been growing at a good pace, while Panera has faced some tough times. However, Panera has been looking to turn its business around and is employing initiatives that have worked well for Chipotle already. So, Panera could turn out to be the next Chipotle, but investors looking for surer bets to benefit from the fast-casual restaurant industry should consider investing in either Buffalo Wild Wings or Chipotle.


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