Taco Bell reported earnings yesterday, and shares of Yum! Brands (NYSE:YUM) rose 7% today on the positive results. Investors may not have bought into David Einhorn's recent claim that Taco Bell will be the downfall of Chipotle Mexican Grill (NYSE:CMG) , but clearly some things are going right at the chain. The company raised its year-end earnings guidance, and the outlook for the rest of the year makes Yum! look like a strong contender. Here's a rundown of the opportunities and challenges that the company still has in store.
Strength of a bear
To lead things off, same-store sales increased 6% in China and 6% in the U.S. Taco Bell drove a lot of that increase with a 7% increase in same-store sales. Pizza Hut scored a 6% increase, and KFC brought up the rear with a 4% rise. As Einhorn pointed out, Taco Bell has launched a number of winners over the past year, including both its higher-end Cantina Bell menu and its popular PepsiCo (NYSE:PEP) brand Doritos-flavored taco shells. Well, there's a sentence I never thought I'd write.
Taste aside, Yum! has also benefited from a strong expansion plan. Last quarter the company opened 192 stores in China alone, which edges it toward its goal of 750 new Chinese stores in 2012. Overall, the company plans on hitting its goal of 1,750 new stores around the world this year. At the end of its last quarter, Chipotle only had 1,300 stores in its entire network.
Yum! said on its conference call that the Cantina Bell offering is bringing in more lunchtime customers, and that average tickets are up for Cantina purchases. That could be a great driver of income over the next year, since it would increase both volume and value for Taco Bell. There's a lot of room to grow, too. Cantina menu items currently make up less than 5% of orders, while the new Doritos tacos account for 7% of orders. The potential value in both of those product lines surely helped Yum! in its decision to raise full-year earnings growth guidance to 13%.
The hurdles in the road
While Einhorn thinks that Taco Bell is going to sound a death knell for Chipotle, I still have doubts. One thing that keeps me from buying that line is something that Five Guys founder Jerry Murrell said when he visited the Motley Fool. When asked how he dealt with competition moving in on his territory, he said that he welcomed it. Five Guys, like Chipotle, sells a common food at a higher-than-average price. Murrell said that when other competitors got in on the game, it helped consumers get used to a higher price point, and as a result Five Guys usually saw its own sales go up.
In short, I don't think that Chipotle competes with Taco Bell. But another company mentioned at the Value Investing Congress, where Einhorn made his proclamation, is in Taco Bell's market -- Qdoba. Qdoba is another quick-bite taco chain, somewhere between Taco Bell and Chipotle in quality. In fact, it's very close to the new Cantina offering. The brand is owned by Jack in the Box (NASDAQ:JACK), and has been on a rapid expansion since its acquisition in 2003.
Qdoba currently has 614 locations, which is still a far sight from Taco Bell's footprint. But expansion is moving quickly, with a 10% increase in stores planned for 2012. The chain has grown from 85 stores in 2003 to its current status, and the Qdoba brand was one of the main factors behind a pitch for Jack in the Box at the Value Investing Congress.
The bottom line
As much as Qdoba adds to the value of Jack in the Box, it's never going to be a serious competitor for Taco Bell's foot traffic. Historically, it seems like the only thing that's stopped Taco Bell from succeeding has been its own failures. This year it got lucky with Cantina Bell and Doritos Locos, and there's still growth left in both of those concepts. But the long term is cloudy. Management isn't worried about a slowdown in China, but at some point that's going to be a problem. If Taco Bell doesn't keep coming up with new ideas, at some point it stops being a great place to invest and becomes merely a decent place.
All that said, Yum! still looks like a good buy. Its P/E is only slightly above the restaurant industry average, and there's at least a solid year of growth to be had. The drawback is that everyone knows it. Especially since the Einhorn declaration, Yum! is on every investor's radar. But the Fool has a special report on 3 Stocks Wall Street's Too Rich to Notice. It's a free report with three overlooked stocks that are ready to jump. As a Fool reader, you can click here to get your free copy today.
Fool contributor Andrew Marder has no positions in the stocks mentioned above. The Motley Fool owns shares of Chipotle Mexican Grill and PepsiCo. Motley Fool newsletter services recommend Chipotle Mexican Grill, Jack in the Box, and PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.