How expensive is too expensive?
Investors seem willing to pay almost anything for growth these days. Take Chipotle Mexican Grill (NASDAQ:CMG), for example. InvestorPlace Editor Jeff Reeves discussed the Mexican food sensation on March 12. Reeves wondered if Chipotle could continue its high-wire act now that bigger competitors, including Yum! Brands (NYSE:YUM), are planning their own premium offerings.
His article got me thinking about a value-oriented investment option. After all, Chipotle’s enterprise value is currently 29 times EBITDA. My solution: San Diego-based Jack in the Box (NASDAQ:JACK), which, in addition to owning the burger chain of the same name, also owns Qdoba Mexican Grill, a poorer cousin to the undisputed champion of fast-casual burritos. Here’s why JACK is the better buy:
Let’s assume for a second that both Chipotle and JACK were acquired by private-equity interests. What would they pay? For simplicity sake, I’ll guesstimate that Jack In The Box might go for a 10% premium, while Chipotle might fetch as much as a 40% premium.
If this came true, Chipotle would cost the buyer $17.9 billion, while Jack in the Box might fetch $1.6 billion. The private-equity boys could theoretically buy Jack in the Box, which includes Qdoba, 11 times over for the price of one Chipotle. Now, let’s assume you’ve sampled both Mexican eateries in the past. Would you pay 11 times the cost of a meal at Qdoba to eat at Chipotle? Not on your life — yet you’re willing to do so with your retirement dollars. Am I the only one who finds that odd?
Steve Ells, CEO of Chipotle, is a brilliant restaurateur. However, not even he could save the three Soul Daddy restaurants (winner of America’s Next Great Restaurant) that closed within two months of opening in 2011.
Every restaurant chain goes through its share of ups and downs. Jack in the Box is working its way through some trials and tribulations at both of its concept chains. At some point, Chipotle will likely face its own issues. Deep-value investors tend to back the downtrodden. Jack in the Box definitely used to be downtrodden, but no longer. Its best days are ahead.
Since we’re talking about dumping Chipotle for Jack in the Box, I’ll start by looking at Qdoba and why it’s a key growth driver for JACK. Compared with Chipotle, the menu is slightly cheaper, with an average check of $9.74, versus $11 for the burrito king. However, that’s $3.49 higher than the Jack In The Box brand.
Long term, JACK plans to open 2,000 units in the U.S. I have no idea when it would achieve such as goal. At present, there are 597 locations, with plans to open approximately 70 to 90 in fiscal 2012, with about half company-owned.
Chipotle has approximately 1,230 restaurants, with plans to add at least 155 in 2012. It will be increasingly more difficult for both chains to find good real estate. Interestingly, while Jack in the Box is lowering its number of company-owned burger outlets, it’s increasing the number of Qdoba locations.
That makes sense given its 25% EBITDA compound annual growth rate over the next five years. Qdoba will contribute 20% of the $2 in operating earnings-per-share JACK expects to generate by 2015. Since Qdoba accounts for just 21% of JACK’s total number of restaurants, the chain clearly is an important part of the future.
Now back to why it makes more sense to own Jack in the Box than Chipotle.
Both expect same-store sales growth in 2012 in the mid-single digits. In the latest fiscal year, Qdoba’s EBITDA margin was 11.3%, versus 18.8% for Chipotle (40% less). Therefore, let’s assume that JACK’s enterprise value is 40% less than the 29 times EBITDA for Chipotle.
That puts JACK’s enterprise value at $426 million — except it’s growing EBITDA by 25% a year. Furthermore, this means that the rest of the business is worth $1.1 billion, or five times EBITDA. Wendy’s (NASDAQ:WEN) enterprise value is 8.6 times EBITDA, and McDonald’s (NYSE:MCD) is 11.2. So something’s out of whack with this valuation picture — and it isn’t McDonald’s or Wendy’s valuations that are awry.
In my opinion, two things are certain: Chipotle is overvalued, and Jack in the Box is undervalued. By how much is up to Mr. Market to decide.
As of this writing, Will Ashworth did not own a position in any of the stocks named here.