McDonald’s vs. Chipotle: Can You Guess Which Is the Better Business?

Both chains have their fans, but which should you want to invest in? Credits: Chipotle's Facebook page and Flickr, with McDonald's photo uploaded by user Astros4477 for use under Creative Commons.

Last time, we compared two burger joints: Five Guys and In-N-Out Burger. This time, we take a look at two quick serve titans with a tangled history.

McDonald's (MCD -0.81%) first invested in Chipotle Mexican Grill (CMG 1.58%) in 1998, holding all the way through to a 2006 IPO that yielded over $1 billion in proceeds. Ironically, Chipotle has created tens of billions more in market value in the years since.

On the other side of the ledger, McDonald's has rarely looked weaker. Patrons are waiting longer to get food they don't particularly like. Mix in labor troubles and a more complicated menu, and you've the makings of a fast food fiasco. Does that mean Chipotle is the better business? Let's consider the financials for each and then decide.

A tightly wrapped burrito baron
In a way, it's an unfair comparison. McDonald's has tens of thousands of restaurants and nearly six decades of operating history. Chipotle is just 21 years old and is only now exploring new concepts, including ShopHouse for Asian food and Pizzeria Locale for made-to-order personal pizzas.

The age difference is easy to spot when looking at the U.S. profile for each company. Chipotle produces one-tenth the sales, yet is growing its footprint 13 times faster, without the benefit of franchising:

Source: QSR Magazine.

The story gets more interesting once you poke around inside the average store. According to most reports I've seen, the average McDonald's covers 4,000 square feet. Chipotle's stores average 2,580 square feet. Thus, in the U.S. last year, Chipotle earned an estimated $770.09 per square foot -- or 22.7% more than the $627.82 earned by McDonald's.

Comparable store sales and returns on capital also favor the burrito baron. Chipotle has seen comps accelerate from up 13.4% in the first quarter to up 19.8% in the latest quarter as the company's simple menu draws raves and foot traffic. Returns on capital -- a measure of management's effectiveness in deploying cash and equity in pursuit of growth -- are up  from 21.6% to 28.7% over the same period, according to S&P Capital IQ.

McDonald's, on the other hand, reported a 0.1% decline in comps in the June quarter after a 0.5% gain in Q1. Only once in the past six quarters have same-store sales grown by 1% or more, S&P Capital IQ reports. Returns on capital have mostly declined over the same period, though at 16.4% they're still healthier than most of the choices on the McDonald's menu.

Cashing in differently
If there's a major difference between these two enterprises, it's that Chipotle -- like In-N-Out -- refuses to franchise, while the majority of McDonald's operating profit comes from franchise-related fees. (Over $1.9 billion in the latest quarter, according to SEC filings.)

Maybe it doesn't matter. But as a franchisor, Mickey D's needn't be as concerned about reinvesting in its network. So it isn't. According to SEC filings, McDonald's spent twice as much third-quarter cash flow on dividends and stock repurchases ($1.5 billion) as it did on capital expenditures ($590 million). Hardly the formula you'd expect for a business in need of an overhaul.

Chipotle is singularly focused by comparison. The burrito baron spent just over $160 million on capital improvements during the first nine months of 2014 versus just $63 million for stock repurchases. Rising returns on capital over that period tells me that management's bets are paying off, which, to my mind, makes Chipotle the better business between these two -- and why I continue to hold shares at current prices.