Chipotle Mexican Grill, Inc. (CMG 0.01%) and Shake Shack (SHAK -0.41%) have won over plenty of hungry customers, but as stocks, the two fast-casual chains have left something to be desired.
Both are trading near 52-week lows as investors seem to have tired of high-multiple restaurant companies, and Chipotle in particular is still coping with the fallout from its well-publicized food safety problems.
The cons with the two stocks are readily apparent: The two fast-casual chains are trading at high valuations and facing slowing growth. Still, there are reasons to be bullish as the two have promising futures ahead of them, and are two of the most well-loved restaurant chains, meaning if each chain can execute its growth plan, the stocks have the potential to double or triple from here.
Let's take at closer look at what each of these stocks has to offer.
A burrito in need of a rewrap
Chipotle was a stock market darling for nearly a decade, climbing almost 40 times from its 2006 IPO price, but that all changed a year ago when reports emerged about an E. coli outbreak in the Pacific Northwest. What was originally thought to be a controlled regional outbreak spread to 14 states across the country, infecting 60 people by the end.
Prior to the E. coli incidents, Chipotle experienced a salmonella and norovirus outbreak, and in December norovirus at a Boston location sickened more than 100 students, and attracted significant media attention as the burrito chain was in the middle of its E. coli crisis.
It's been more than eight months since the CDC declared an end to the outbreak, but Chipotle's sales are still off sharply. Comparable sales were down 24% in its most recent quarter despite multiple promotions. Management was slow to respond to, and apologize for, the E. coli outbreak and has at times blamed the sales slide on social media, incremental reporting from the CDC, and the media in general.
Still, customers were turned off, especially since Chipotle has claimed its slogan "Food with Integrity," touting local and organic produce and humanely raised meat, the implication being that it was more wholesome than traditional fast food. That position the company had worked so hard for seemed to disintegrate with many of its customers following the outbreak. And even today, management seems distracted from the core issue. The company plans to open its first Tasty Made burger restaurant this fall and released a short animated film over the summer in line with its other marketing shorts, but not much has been done to reach out to customers who have abandoned the chain. A rewards program over the summer treated frequent visitors, but that's not who the company needs to win back.
Every publicly traded restaurant chain that's experienced such a foodborne illness outbreak has bounced back, and that includes Jack in the Box, where four children died from a massive E. coli outbreak in the 1990's. But Chipotle's recovery is taking longer than many expected. It should get better in the fourth quarter when it laps the beginning of the crisis, but with profits slashed to a fraction of where they were, a recovery to full health is not guaranteed.
Too hot to handle
While Chipotle may be a victim of its marketing message, Shake Shack seems to be a victim of its own success. The stock flew out of the gate following its IPO last January, nearly reaching $100, but is now trading around $32, near its 52-week low. Its performance has been essentially flawless since it debuted as it's beaten earnings estimates in every report. However, same-store sales growth has slowed and according to the market, that's a concerning sign for a company with a P/E of 81. Comparable sales growth slowed to 4.5% in its second quarter, and management expects that figure to fall to just 1% to 3% in the second half of the year.
Concerns about an industrywide recession also may be weighing on the stock as several other restaurant chains are experiencing similar pullbacks. Still, Shake Shack seems to be executing on all parts of its growth plan. For the second year in a row it accelerated the number of new store openings, this time to 18. It's expanded its menu with the launch of the ChickenShack chicken sandwich, and recently added a mobile app to test ordering ahead of time at one location.
With average sales volume at its restaurants around $5 million, much higher than any other fast food chain, it may be more important for the company to open new locations, rather than deliver blockbuster same-store sales growth. The earnings multiple may scare away some investors, but Shake Shack has just started on its path to 450 domestic company-operated restaurants, and should be easily able to grow into its valuation over time.
Which is the tastier stock?
Though both stocks are facing high multiples to overcome, Chipotle's foibles with the food safety crisis make it the riskier of the two. Meanwhile, Shake Shack has more than delivered on everything investors have expected thus far -- the stock has just struggled recently due to its high valuation. Over the next couple of years, I'd expect the better-burger chain to grow into investors expectations, eliminating those concerns.
With Chipotle still seeing sales and profits fall as it struggles to restore its image and Shake Shack putting consistently strong growth and industry-leading unit volumes, Shake Shack is the better buy of the two today.