MCD: McDonald's vs. Chipotle: Which Stock is a Better Buy?

The restaurant industry has been profoundly impacted by the COVID-19 pandemic, which has forced millions of stores worldwide to remain closed since March or to operate at reduced capacity when restrictions were eased in the summer. Despite these disruptions, McDonald’s Corporation (MCD) and Chipotle Mexican Grill, Inc. (CMG), two of the world’s prominent fast-food restaurant companies, have stayed afloat by rapidly adapting to a new consumer preferences for digital sales and delivery services.

MCD is one of the world’s leading global food service retailers with more than 39,000 locations in over 100 countries worldwide. Its restaurants offer various food products and beverages, as well as a breakfast menu. Approximately 93% of MCD’s restaurants are franchised and operated by independent local business owners. The company functions through three segments – U.S., International Operated Markets, and International Developmental Licensed Markets & Corporate.

CMG develops and operates fast-casual and fresh Mexican food restaurants. It has more than 2,700 restaurants in the U.S. and internationally and is the only restaurant company of its size that owns and operates all its restaurants. It operates primarily via two segments – Food and beverage, and Delivery service.

Both stocks have generated decent returns over the past three years. While MCD returned 33% over this period, CMG gained 383%. In terms of year-to-date performance, CMG is a clear winner with 70.4% returns versus MCD’s 9.9%. But which of these stocks is a better pick now? Let’s find out.

Latest Movements

Last month, MCD announced a new growth strategy, Accelerating the Arches, that encompasses all aspects of the company’s business as the leading global omni-channel restaurant brand. However, the company has also asked its franchisees to shoulder more costs beginning in 2021. MCD expects its franchisees to pay technology investment expenses it previously covered and to bear a part of the worker career training programs, despite beaten-down sales and pandemic-led shutdowns.

CMG opened its first-ever digital-only restaurant called the Chipotle Digital Kitchen in New York last month. It will facilitate pick-up and delivery only. The prototype will allow Chipotle to enter more urban areas that would not support a full-size restaurant and allows for flexibility with future locations. Moreover, the company is constantly innovating its menu, and is currently testing new dishes at 64 restaurants.

Recent Financial Results

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In the third quarter ended September 30, 2020, MCD’s revenue declined 2% year-over-year to $5.5 billion, due to higher sales-driven restaurant margins in the United States. This was partly offset by poor sales performance in the other two segments. Franchised restaurants contributed 56.2% to the top-line. Adjusted EPS came in at $2.22, improving 5% year-over-year.

CMG’s revenue for the third quarter grew 14.1% year-over-year to $1.6 billion. A significant portion of the revenue increase came from its digital sales, which grew 202.5% year-over-year and accounted for 48.8% of the overall top-line. The company opened 44 new restaurants during the third quarter and closed three restaurants. However, CMG’s EPS came in at $2.82, declining 18.7% year-over-year.

Past and Expected Financial Performance

MCD’s revenue and EPS have declined at a CAGR of 6.8% and 1.7%, respectively, over the past three years. Also, the company’s free cash flow has fallen at a CAGR of 9.5% during the same period.

Analysts expect MCD’s revenue to increase 0.7% in the current quarter and 13.9% next year, but to decline 8.4% in the current year. The company’s EPS is expected to decline 8.1% in the current quarter and 20.8% in the current year but rise 34.3% next year. Moreover, its EPS is expected to grow at a rate of 5.6% per annum over the next five years.

CMG’s revenue and EPS have grown at a CAGR of 9.8% and 17.7%, respectively, over the past three years. The CAGR of the company’s free cash flow has been 24.1%.

Analysts expect CMG’s revenue to increase 11.8% in the current quarter, 15.7% in the current year and 17.1% next year. The company’s EPS is expected to grow 31.8% in the current quarter and 94.7% next year but decline 21.6% in the current year. Moreover, its EPS is expected to grow at a rate of 25.8% per annum over the next five years.

CMG has an edge over MCD here.

Profitability

MCD’s trailing-12-month revenue is more than three times CMG’s. Moreover, MCD is more profitable, with a gross profit margin of 51.4% versus CMG’s 33.7%. However, CMG’s ROE of 13.8% compares favorably with MCD’s negative value.

Valuation

In terms of forward P/E, CMG is currently trading at 147.92x, 335% more expensive than MCD, which is currently trading at 34.01x. Though CMG is less expensive in terms of trailing-12-month P/S (6.83x versus 8.30x), its forward PEG of 6.19x is 41% higher than MCD’s 4.38x.

In terms of trailing-12-month price/cash flow, CMG’s 54.27x is111.7% higher than MCD’s 25.63x.

Though CMG looks much more expensive compared to MCD, we think it is worth paying this premium considering CMG’s higher earnings growth potential.

POWR Ratings

While MCD rated “Buy” in our proprietary POWR Ratings system, CMG is rated “Strong Buy.” Here are how the four components of overall POWR Rating are graded for MCD and CMG:

MCD has an “A” for Trade Grade, “B” for Buy & Hold Grade and Industry Rank, and a “C” for Peer Grade. In the 49-stock Restaurants industry, it is ranked #13.

CMG has an “A” for Trade Grade, Buy & Hold Grade and Peer Grade, and a “B” for Industry Rank. It is ranked #2 in the same industry.

The Winner

Both MCD and CMG are good long-term investments considering their global market dominance, rapid adoption to the online and drive-thru sales, and the recovering overall food-service industry. However, CMG appears to be a better buy based on the factors discussed here.

While MCD is a bigger and established player and is a relatively cheaper option to bet on currently, CMG is growing rapidly through its digital sales initiatives, third-party delivery collaborations and effective menu innovation. Consequently, we think its premium valuation is justified given that it has more room to grow its earnings.

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MCD shares . Year-to-date, MCD has gained 9.97%, versus a 16.33% rise in the benchmark S&P 500 index during the same period.

About the Author: Sidharath Gupta

Sidharath’s passion for the markets and his love of words guided him to becoming a financial journalist. He began his career as an Equity Analyst, researching stocks and preparing in-depth research reports. Sidharath is currently pursuing the CFA program to deepen his knowledge of financial anlaysis and investment strategies. More...