# Fast-Food Restaurants

Within the restaurant industry, there is a segment referred to as the Informal Eating Out (IEO); for the layman, these are fast-food restaurants. In general, there are no hostesses, table servers, or alcohol served. This is a \$1.4 Trillion industry worldwide.

## Starbucks – Intrinsic Value for Value Investing

What would you pay for a stock that has the following negative attributes?

A book value of MINUS \$7.33 per share (yes, you read that correctly, a negative book value);
A recorded deferred liability to Nestle Corporation for almost \$6.6 Billion;
Decreased the company’s already negative equity position another 60%, i.e. \$3.1 Billion more;
Has 5,358 locations in China which is 31% of its corporate owned stores;
Spent \$3.5 Billion to buy back 3.1 Million shares when the price of its stock was at or near its historical high market value;
Has long-term debt and leases totaling \$23.5 Billion with fixed assets of only \$15.2 Billion.

Yet, with all these negative factors, Starbucks’ stock price is currently in the mid 90’s range and was selling at an all-time high of \$126 per share back in the middle of the summer 2021. Mind you, the company’s stock price was a mere \$5 per share just 13 years ago. If you exclude 2020’s financial results due to COVID-19 and average the last 3.25 years (2018, 2019, 2021 and the 1st quarter of 2022) you get an average annual earnings of \$4,040.8 Million (\$4.04 Billion). Using Graham & Dodd’s core formula to calculate value and assuming a 7% growth rate, total market value equals:

Average Earnings X ((8.5 plus (2 Times Average Expected Growth Rate)) = Market Value
\$4,040.8 Million X (8.5 plus 14) = Market Value
\$4, 040.8 Million X 22.5 = Market Value
Market Value = \$90,918 Million (\$91 Billion)

With 1,176.6 Million shares in the market, each share is worth about \$77.27 per share. At a more realistic 5.5% growth rate, each share is worth about \$67/share. Even using the best quarterly results in the last four years and extrapolating this as the average quarterly amount for an entire year, average earnings per year would equal \$5.93 Billion and with an average annual growth rate of 5.5%, the market value would approximate \$115.6 Billion or about \$98 per share.

Thus, assuming some strong liberal values, at most, Starbucks is worth \$98 per share. With more conservative elements of the formula, Starbucks is worth less than \$67 per share. This article, will illustrate that the actual intrinsic value is less than \$40 per share; and, this is using reasonable estimates for the elements of several different intrinsic value formulas.

## Chipotle Mexican Grill, Inc. – Intrinsic Value for Value Investing

Chipotle Mexican Grill, Inc.’s current (01/24/22) market price is around \$1,400 per share, trading as high as \$1,930 late last summer (summer of 2021). The market price is hyped up on the strong belief that this company will generate incredible results over the next few years. The truth of the matter is this: even if you took the absolute best quarterly results from the last five years, extrapolated that value as the normal value for Chipotle, then doubled its growth rate, the maximum best value for Chipotle would equal \$480 per share. To put this succinctly, the market price for this stock is so overpriced that the best term to describe this is ‘irrational exuberance’ (Alan Greenspan, December 5, 1996).

There is no doubt this company produces a great product that is loved by millions of consumers. Even more, Chipotle has grown in leaps and bounds with volume of restaurants over the last ten years (adding 1,300 restaurants in eight years); it currently has 2,900 locations. More importantly, Chipotle’s gross margin has improved to a respectable 11.9%. Add to this, Chipotle has not recorded a loss during the last ten years. However, Chipotle’s financial model does not mirror the fast-food restaurant financial model customarily found with franchised operations such as McDonald’s, Wendy’s, Restaurant Brands International and Dominos. Furthermore, the law of diminishing returns will begin to dampen growth and impact the ability of Chipotle to maintain a high quality meal served in a reasonable time frame. In effect, the growth experience that Chipotle has seen can not continue in the long-run. Instead of seven and eight percent annual growth rates experienced over the last ten years, growth will shrink to a more realistic four and five percent per year.

## Wendy’s – Intrinsic Value of Stock

Wendy’s is the second largest publicly traded informal eating-out (fast-food) hamburger chain. Its current market capitalization places it around \$5 Billion. Therefore, it falls into the mid-cap arena of stocks. At the time of this article’s inception, November 2021, Wendy’s was trading on the NASDAQ at \$23 per share. Its intrinsic value is a little less than half the market value and a value investor’s buy point is around \$8 per share. The company does pay a small dividend. Current dividend yield is slightly less than 2%. Overall, the company is profitable but stagnant related to growth. Stated succinctly, Wendy’s is nowhere near worth a current market value of more than \$20 per share.

This company runs the industry financial model commonly used with other fast-food restaurant chains. It has three revenue and expense segments of operations. The first and core segment is the traditional corporate owned locations. Wendy’s has 361 company owned stores. As such, they have a traditional profit and loss calculation associated with this segment. A second segment and the real driving force of profit is the franchising arm of the company. There are 6,467 franchisees, with corporate owned stores, Wendy’s totals 6,828 restaurants. This segment is driven by the 4% franchise fee placed on all sales of the franchisees. Similar to McDonalds, the core source of profitability stems from the franchising aspect of operations. A third and not as profitable as franchising is the real estate arm. Just like McDonalds and other well managed restaurant chains, Wendy’s negotiates long-term leases of property in ideal locations and in turn negotiates beneficial long-term leases with franchisees to pay rent for the use of that land. The franchisee uses their capital to build the store, equip it and initiate operations at that site.

## Shake Shack – Intrinsic Value of Stock

One of the members of the informal eating out industry, fast-food restaurants, is Shake Shack. Shake Shack is one of the few fast-food restaurants that sells beer and wine at a limited number of its locations. The company is relatively young by any business standard opening its first restaurant back in 2001 and going public in 2014. Thus, the company does not qualify as a value investment opportunity but is used as a comparative tool in this site’s Value Investment Fund’s Fast-Food Restaurants’ Pool.

In general, Shake Shack’s market price is several times greater than the company’s intrinsic value. It is trading at this high price purely on conjecture that it will morph into the next McDonald’s. Based on its business plan, historical earnings, and capital raising capacity; it will take every bit of twenty (20) years to justify the current market price – trading at more than \$70 per share (November 2021). No value investor in their right mind would spend \$70 plus on hope. It is simply irresponsible.

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