Darden Restaurants, Inc. (DRI), Chipotle Mexican Grill, Inc. (CMG): Dealing With the Fast Casual Threat

With the success of fast-casual chains like Chipotle Mexican Grill, Inc. (NYSE:CMG), companies far and wide are trying to deal with the niche segment that sits between fast-food giants like Yum! Brands, Inc. (NYSE:YUM) and casual players like Darden Restaurants, Inc. (NYSE:DRI).

Fast casual tries to be the best of all worlds, with better quality than fast food and lower prices than casual dining. The star of the industry is Chipotle Mexican Grill, Inc. (NYSE:CMG), which has seen its top and bottom lines grow steadily since 2007, notably the start of the deep recession that lasted into 2009 and stalled growth at many a competitor.

The company’s sales have more than doubled since 2007, going from $1.1 billion to $2.7 billion. Earnings have advanced from about $2.15 a share to $8.75. A powerful combination of store openings and repeat business have been the driving force behind this explosive growth. The shares trade with a price to earnings ratio of around 44, however, so they are far from cheap.

Copycats

Still, fast food companies are working hard to compete. Yum! Brands, Inc. (NYSE:YUM) is one of the more aggressive ones in the space. It has already tried to spruce up its Taco Bell brand’s offerings. There it brought out the “Cantina” menu with higher quality fare, including a bowl dish that is a clear rip-off of a core Chipotle Mexican Grill, Inc. (NYSE:CMG) offering. More recently, the company has announced plans to test a higher-end KFC concept called KFC Eleven.

Yum! Brands, Inc. (NYSE:YUM) shares have been trading roughly sideways for about a year. That’s not surprising since it has been dealing with major chicken quality issues in China, a market that it has pegged as core to its long-term prospects and that made up about 40% of its profits last year. That said, investors seem to have looked past those problems despite what appears to be the start of an economic slowdown in the Asian giant, pushing the company’s shares generally higher since the middle of April.

That’s odd since sales have been lower quarter over quarter for the last three quarters and earnings have been lower for the last four quarters. That said, the company reports that KFC’s China business is starting to recover, which should help put a floor under the company’s results. And domestic results have been relatively strong.

With a P/E of around 24, however, the still recovering company is being afforded a premium of about five percentage points above its trailing five-year P/E. Trying to ape fast casual concepts won’t likely change the company’s fortunes enough to justify that premium.