Should McDonald's Buy Chipotle?

Retail

Published: August 25, 2014 6:37 am

Revenue grow at McDonald’s Corp. (NYSE: MCD) is nearly nil, and it is in trouble with governments in Russia and China. The fast-food operator once controlled the ownership of white-hot Chipotle Mexican Grill Inc. (NYSE: CMG). Maybe it should buy the chain back again.

The consolidation of fast-food operations may already be underway. Burger King Worldwide Inc. (NYSE: BKW) is in talks to buy Canadian firm Tim Hortons Inc. (NYSE: THI). Part of this deal would allow the new company to relocate to Canada for better tax treatment. McDonald’s would have no such good fortune with Chipotle because each is located in the United States. However, it could acquire some of the growth rate it has lost as consumers have deserted its menu of fatty foods and sugary drinks.

McDonald’s bought into Chipotle in 1998. By 2006, it had spun out the Mexican food restaurant into a new public company. As some measure of the spinout’s success, Chipotle shares have risen 700% in the past five years. The S&P 500 is up approximately 100% over the same period. The rise in McDonald’s shares is barely half of that, even though it has completed a nearly record set of dividend increases and share buybacks. Its dividend yield is 3.4%, which makes its stock more like a bond than the equity of a growth company.

Chipotle’s market cap is large by the measure of fast-food chains at $21 billion. For the sake of comparison, Burger King’s market cap is less than $10 billion. Despite trouble at McDonald’s, its market cap is $93 billion, primarily because of its size. McDonald’s revenue was $7.2 billion in the second quarter, on which it had net income of $1.4 billion. Chipotle’s revenue for the same period was $1.1 billion, on which it had net income of $110 million. However, Chipotle is growing at a rate of 20% to 25%.

McDonald’s would have to pay at least $30 billion for Chipotle, which would make the deal extraordinarily expensive, based on the Mexican chain’s earnings. However, McDonald’s management has made it clear it may be unable to jump-start its U.S. sales for over a year. And that forecast may be optimistic. Too many of its customers have fled elsewhere, including Chipotle, and may never come back.

McDonald’s management can intelligently admit its U.S. expansion is over and buy a company that may be only at the beginning of its run.

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