When it comes to fast food and specialty restaurants, many investors instinctively flock to Chipotle Mexican Grill (NYSE:CMG). There's good reason for this, of course, since Chipotle has had a great run over the past few years. But whether its amazing rally can continue is a separate question. At more than $670 per share, Chipotle holds a lofty valuation that should give investors pause. Growth investors see the company's stellar earnings results as reason to keep buying, but it's worth noting that Chipotle's tremendous growth may already be priced in to the valuation. Consider that Chipotle stock trades for 52 times earnings. In other words, if Chipotle's growth fails to meet its high expectations, as happened last quarter, the stock may perform poorly.
That's why growth investors may want to consider a much smaller, cheaper, and less-followed company in the space, Popeyes Louisiana Kitchen (NASDAQ:PLKI).
Popeyes' big advantage
Most people know that traditional burgers and fries chains are having a hard time growing, because consumers may be getting bored with the same old fast-food menus. Popeyes offers a truly differentiated experience because of its "New Orleans" style menu that contains items like fried chicken and shrimp. This has kept the company's growth on track while others in the fast-food space struggle.
According to Popeyes, $100 invested in its stock on Dec. 28, 2008, would have been worth $869 at the end of last year. That's a huge return over a five-year period. By comparison, an equal investment in the S&P 500 Index would be worth $235 -- a satisfactory return, but nowhere near Popeyes. And Popeyes' stock is up 26% so far this year.
Popeyes is growing sales and profitability simultaneously. Between 2011-2013, Popeyes grew total revenue by 33%. In addition, the company's margins expanded. Profit margin grew from 15% to 16.5% during this period. This demonstrates the power of the business, to not only increase sales due to growing store count, but also by expanding profitability at the same time.
Compelling future growth potential
Both Chipotle and Popeyes are doing very well in the United States. Where Popeyes has a strong advantage is in the international markets. Chipotle has so far resisted the urge to meaningfully expand overseas, holding a tiny amount of international restaurants. Instead, Chipotle focused on its growth opportunities here in the United States. And while that decision has certainly worked out to its benefit, its future in the U.S. won't be nearly as lucrative as its past. That's because Chipotle has opened a large number of new stores all across the United States, which means that sooner or later, Chipotle's growth here is going to slow down.
This is plain to see from Chipotle's recent earnings report. Part of the reason the stock sold off after that report was that the company gave a dour forecast for growth next year. In 2015, Chipotle management expects low-to-mid single digit same-restaurant growth on a percentage basis. That is a significant slowdown, and because of this, it may be time to consider overseas expansion.
Popeyes began expanding into international markets long ago, wisely seeing the limit to domestic growth potential. The company franchises nearly 400 international restaurants, comprising roughly 20% of its total. There's room for growth, since Popeyes hasn't yet fully penetrated the premier emerging markets known as the BRIC nations: Brazil, Russia, India, and China. Approximately 55% of Popeyes' franchised international restaurants are located in Korea, Canada, and Turkey.
And, Popeyes might even have an advantage as far as the domestic market is concerned. Like its international business, its U.S. operations are highly concentrated. According to Popeyes' annual report, 71% of its domestic franchised restaurants are located in just 11 states. There are several states in which Popeyes has no presence at all. Clearly, there's still strong growth potential here in the United States that could represent a catalyst.
Chipotle stock is as pricey as its menu
There is no doubt that Chipotle is a fantastic business. The problem with Chipotle comes purely from an investment perspective. Chipotle's future growth trajectory appears priced in to its aggressive valuation. When this happens, growth stocks often sell off even when they report outstanding results. Even though Chipotle's earnings grew 56% last quarter, the stock dropped 7% after reporting.
Chipotle trades for 52 times trailing earnings and 38 times forward EPS estimates. By contrast, Popeyes trades for 30 times trailing earnings and 24 times forward EPS. Popeyes is just a $1 billion company by market capitalization, while Chipotle holds a $19 billion market value. Judging by these figures, it seems that Popeyes has more room to grow than Chipotle.
The bottom line is that while Chipotle is a great company, it's much further along in its growth trajectory than Popeyes. Popeyes is just starting to gain traction, particularly in the emerging markets. As the company grows its restaurant count and acquires scale, strong earnings growth should follow due to high sales growth and margin expansion. That's why investors on the hunt for growth stocks should give Popeyes a closer look.