Forget Chipotle, Buy This Instead…

Shares of Chipotle (NYSE: CMG) have had a rocky year in 2016. Last quarter’s weak earnings report showed that the company is still suffering in the wake of the E. coli and other health-related outbreaks. 

These health scares have led to a fall in traffic to its stores and Chipotle can’t quite figure how to get customers excited again, much less investors. 

#-ad_banner-#Same-store sales (those opened for longer than a year) were down a whopping 29% in Q1. Second quarter same-store sales will likely be down 20%, which is tracking below Wall Street expectations. 

Yet, with the stock down 28% over the past 12 months, it’s now convincing value investors like myself to take a closer look. But I’m finding that Chipotle might still have a lot of issues with no quick or easy fix. 

But Is There A Silver Lining?
Now, there could be an opportunity for Chipotle to rekindle eaters’ interest. This includes rolling out new menu items and potentially breaking into the heated breakfast market.

The company has already announced that it plans to start offering chorizo as a protein option in its restaurants. 

Then there’s the breakfast opportunity. Breakfast has proven to be big business these days. Yum! Brands (NYSE: YUM)’s Taco Bell has rolled out breakfast and Starbucks (Nasdaq: SBUX) continues to add hot breakfast items, like sandwiches, to its stores. 

Part of what will likely keep Chipotle out of the breakfast market is the relative expense of cooking both lunch and breakfast. Also, Chipotle would have to up its labor costs by opening its stores earlier. 

The other big headwind for Chipotle is the rapid rise of competition in the fast casual restaurant space. Since there’s little to no switching costs for customers, making it necessary for Chipotle to compete on price and food quality, the latter of which has been called into crisis by highly publicized outbreaks. Chipotle is considering offering promotional deals, such as buy one get one free, but such promotions will hurt margins.

The Best Play In Fast Food
But there are other places in the restaurant industry to look for value opportunities. 

The stock price of McDonald’s (NYSE: MCD), the former partner company of Chipotle, has done the complete opposite of Chipotle over the past 12 months — its stock is up 33%. 

McDonald’s rollout of its all-day breakfast has been a big success. The company has posted positive same-store sales for three straight quarters now. First quarter 2016 profits were up 35% from the same quarter last year, thanks in large part to all-day breakfast, and same store sales were up 6.2%. 

We still likely haven’t seen the full effect of all-day breakfast at McDonalds, where the company continues to adapt its offerings to individual markets and source items like cage-free eggs to take advantage of the organic and natural foods trend — a proposition that helped make Chipotle a success. Additionally, McDonald’s has just started serving all-day breakfast in Australia and is looking at areas of Europe for the next expansion. I expect these moves to continue to drive same-store sales higher for the company. 

Meanwhile, McDonald’s is also doing a very nice job on the marketing front, having success with promotions like McPick 2, which included two items for two dollars. It’s also still planning to simplify its menu and offer more personalization, with the help of new customer friendly technologies such as self-ordering kiosks. 

Risks To Consider: With McDonald’s stock already having an impressive run, it’ll need to continue executing flawlessly to keep investors happy. And there’s still uncertainty over just how far they can expand all-day breakfast and to what extent the novelty of the offering wears off. There is also risk of poor execution of future customization and personalization options.   

Action To Take: McDonald’s is already at all-time highs while Chipotle is near lows. But the biggest player appears to best when it comes to investing in the restaurant space. 

Chipotle trades at 40 times earnings, while McDonald’s is at 25 times earnings and the much more compelling investment. Additionally, McDonald’s is offering an enticing 2.7% dividend yield. For investors looking for the best bets in the restaurant space, they are better off avoiding Chipotle and taking a closer look at McDonalds.

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