Founded in 1993 in Denver, Colorado, Chipotle Mexican Grill brought about a sort of renaissance in limited-service restaurants, albeit in a new, healthier subset we now call fast casual. Not only did it spark a surprising wave of growth in the quick-service restaurant format, but it challenged traditional fast-food companies to offer healthier options and to innovate.
However, as fast-casual sales soared, entrepreneurs quickly caught on to the trend. Formidable fast-casual competitors have since gained steam in virtually every food category. There's Shake Shack's burgers, Zoe's Kitchen's Mediterranean food, Noodles & Company's noodle-style cuisines from around the world, Jack in the Box's burritos at its Qdoba chain, and plenty more.
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The first thing investors should know about the fast-casual industry is that it's not the Wall Street darling it once was. Sales growth has slowed, and fast-casual restaurant stock prices have come back down to earth. Indeed, U.S. fast-casual sales in 2017 are estimated to grow just 6% to 7% year over year, according to a report on the industry by Pentallect. This is down significantly from the 10%-plus annual growth the industry has seen in recent years, according to Pentallect.
In some ways, the industry's slowdown got a head start last year, thanks to Chipotle's food safety scares that surfaced in late 2015 and plagued the burrito giant into 2016. Fast-casual sales slowed from 12% year-over-year growth in 2015 to 8% growth in 2016. But industry research by National Restaurant Association shows that this growth would have been 10% if not for Chipotle's colossal food scare that sent comparable-store sales plummeting.
Of course, a sudden deceleration in industry growth and lower stock prices in the segment means there may be some undervalued opportunities. While I'm not ready to buy into any of these stocks until I can find more signs of durable competitive advantages in this nascent (and apparently volatile) market, two companies have made it on my radar and may be worth putting on your watchlist for further consideration.
On my radar
Chipotle Mexican Grill: Chipotle stock has been absolutely slammed in the past few years, sliding about 60% since the summer of 2015. As the king of fast casual itself, it's definitely worth taking a look at Chipotle as it finally shows signs of a recovery.
Chipotle's stock took a big hit as recently as October, when the fast-casual pioneer reported revenue, earnings per share, and comparable restaurant sales that were all below analyst estimates for the quarter. During the quarter, Chipotle's revenue climbed 8.8% year over year to $1.13 billion, but was still below its $1.2 billion of third-quarter revenue two years ago -- before its food safety public relations nightmare.
However, there are reasons for investors to begin looking up. Chipotle's comparable restaurant sales are in positive territory again. In the third quarter of 2017, comparable-store sales were up 1% year over year. In addition, Chipotle recently overhauled its mobile app to cash in on the growing trend of mobile ordering. The move is one of many management plans to make in an effort "to improve its guest experience through technology and innovation," said Chipotle's chief digital and information officer in a press release in November.
Jack in the Box: As investor interest in fast-casual stocks waned in 2016 and 2017, there was a resurgence in the popularity of traditional fast-food restaurant operators -- a trend that makes Jack in the Box particularly interesting, as the company boasts the best of both worlds. For fast food, it has its 2,200 Jack in the Box locations, which more closely resemble McDonald's and Wendy's than the fast-casual dining format. But Jack in the Box also owns Chipotle's chief competitor, Qdoba Mexican Eats, which has 700 restaurants across 47 states.
In Jack in the Box's most recent quarter, revenue fell 3% year over year. In addition, management admitted that though same-store sales trends improved sequentially, overall performance was below management's expectations as Jack faced headwinds from higher labor, repairs, and maintenance costs, as well as commodity inflation.
During the quarter, system same-store sales for Jack in the Box were down 0.2% year over year. But in the same period, system same-store sales at Qdoba were up 0.5%, highlighting positive trends on the fast-casual front. Overall, management seemed pleased with Qdoba during the quarter.
Jack in the Box CEO Lenny Comma commented on Qdoba's solid performance:
Investors interested in Jack in the Box should also keep in mind that management has been considering the possibility of spinning off its Qdoba brand. So, if investors believe there's significant upside for Qdoba, a transaction like this could potentially unlock more value for Jack in the Box shareholders.
While it's tough to identify what fast-casual companies will come out ahead in the coming years, one trend in the segment is as clear as day: Fast-casual restaurants are gaining market share in the overall limited-service segment. In 2007, fast casual accounted for just 7% of U.S. limited-service restaurant sales. By 2016, National Restaurant Association estimates this share had risen to 18%. Looking ahead, it forecasts that fast casual will capture 22% of the segment's sales in 2021.
Stocks like Chipotle and Jack in the Box look poised to benefit from these trends.
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