When looking at fast-food competitors Chipotle Mexican Grill (NYSE:CMG), Yum! Brands(NYSE:YUM), and McDonald's (NYSE:MCD), the burrito maker has the smallest global presence, but that doesn't mean shareholders should underestimate just how mighty its management is.
In debt we trust
Chipotle has a lot of things going for it: social responsibility, an innovative corporate culture, a great free-form menu. But perhaps the most important aspect of the Mexican grill is how it manages its assets. Since 2007, Chipotle has had zero short or long-term debt, so it has only had to focus on investing its equity in a profitable manner. Yum! and McDonald's, on the other hand, have both been leveraging themselves quite substantially for the last decade, if not longer. Check out the total debt of all three restaurant chains:
Sure, it takes a lot of cash to run global operations like Yum! or McDonald's, but just how effectively are the companies managing their assets? In order to break it down, let's make sure we, as shareholders, have a solid understanding of what to glean from looking at a company's return on assets, or ROA.
Companies generally have both debt (though not in Chipotle's case, as mentioned above) and equity, which we refer to as the company's assets. Companies draw from both types of financing to fund operations. Looking at ROA gives shareholders an idea of how effective a company's management is at converting its assets into net income. Determining a company's ROA involves dividing its net income by its total assets, leaving us with a percentage. The higher the percentage, the better.
A company has a high ROA is likely to be managing its finances in a way that earns it more cash on less investment. Essentially, folks should invest in companies that are managed by folks who can allocate resources in an efficient and resourceful manner, thus making more cash with little investment.
Now that we have a basic understanding of what ROA can tell us, let's digest Yum!'s, McDonald's, and Chipotle's numbers and see which goes down the easiest.
Hard to swallow
Yum! (parent company to Taco Bell, KFC, and other chains) saw pretty steady ROA growth until 2012, at which point its return plummeted from almost 18% to the lowest point it has seen in a decade, just over 12%. Perhaps this was due to the company's inability to effectively manage the effect that an outbreak of avian flu had on its KFC sales in China.
Stores that were open at least a year in that market saw sales drop by about 11%. Since Yum! gets about three-quarters of its revenue from outside of the U.S, this steep ROA drop should have shareholders questioning the company's ability to effectively manage its massive assets during times of trouble.
Back in 2007, McDonald's saw a ROA dip much like Yum!'s, but it was able to build back from about 8% all the way up to almost 15% by 2008. Yum! might see the same trend, but it will have much more ground to make up. McDonald's was able to effectively manage its operations in order to overcome that ROA dip, and it has been quite steady since then.
Easy going down
Chipotle hasn't seen too many ROA dips; in fact, shareholders should be pleased to note that the Mexican grill has had pretty steady growth in this area. Obviously, Chipotle is a much smaller company; it has about 1,600 locations, compared to Yum!'s roughly 40,000 and McDonald's' more than 35,000, so managing its assets is intrinsically less complicated than for its global competitors.
Keeping its operations small and simple, and managing growth in an efficient manner, has put Chipotle ahead of both Yum! and McDonald's when it comes to ROA. The burrito boss' ROA is about 5.5 percentage points above Yum! and is outperforming McDonald's by about 2.3 points.
For good times, make it burrito times
Chipotle has proven itself a well-led company. Keeping its debt down to zero while managing its equity in an efficient and resourceful manner has allowed it to run circles around Yum! and McDonald's. Perhaps bigger isn't better, as its comparatively smaller operations may make Chipotle adaptable to the changing tides of the restaurant industry. While its historic performance is stellar, shareholders should keep an eye on Chipotle's ROA as the company navigates its expansion into Italian and Southeast Asian fare with its Pizzeria Locale and ShopHouse brands.
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Leah Niu owns shares of Chipotle Mexican Grill. The Motley Fool recommends Chipotle Mexican Grill and McDonald's. The Motley Fool owns shares of Chipotle Mexican Grill and McDonald's. 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.