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Chipotle (CMG), McDonalds (MCD), and the Rise of Quality Fast-Casual Dining

The United States is the country that brought the world fast food. Or at least fast food of the greasy, sub-standard cheeseburger or fried chicken variety. Chains like McDonalds (MCD) , Burger

The United States is the country that brought the world fast food. Or at least fast food of the greasy, sub-standard cheeseburger or fried chicken variety. Chains like McDonalds (MCD) , Burger King (BKW) , and Kentucky Fried Chicken (YUM) have become global, with locations popping up across the planet. They’ve become a symbol of America that’s spread far and wide, and they’ve provided investors with consistent returns. McDonalds has given returns approaching 300 percent over the last decade, and YUM! Brands (the owner of Kentucky Fried Chicken as well as Taco Bell and Pizza Hut) is up over 350 percent over that same period. And that doesn’t factor in their dividends of 3.43 percent and 2.07 percent respectively.

McDonalds (MCD) Stock on a Pleateau?

That’s why the relatively flat performance of these stocks since the start of 2012 stands out. Since the start of 2012, McDonalds is down almost 6 percent. YUM!, meanwhile, is up over 20 percent over that period. But that includes a rapid rise that peaked on April 20th of last year. If you go from May 1, 2012, YUM! is down over 2.5 percent.

Certainly, with a healthy dividend and a strong history of performance, it could be a serious mistake to overstate the importance of less than two years of performance. However, it’s also hard to ignore over 18 months of stagnation for the two biggest players in the segment. And in this case, it could also point to a larger underlying trend that means trouble for the biggest fast food chains.

Foodies Abound

Food culture in America is changing, and it isn’t hard to spot the trend. The Food Network (SNI) has gone from its launch in 1993 as a small, niche channel to reaching nearly 100 million homes. With it has come the major success of food oriented shows on the Travel Channel, Bravo, and the major networks. Last year, there was a 10 percent jump in the number of FDA registered farmers markets to 7,864. In 1994, there were 1,744, meaning the number’s jumped over 350 percent in just under 20 years. And grocery stores catering to more selective customers are showing tremendous growth. Since the start of 2009, Whole Foods Market, Inc. (WFM) is up over 1200 percent. On the whole, the rapid expansion of food culture in the United States has changed the way many people are eating and getting their food.

But how might this bleed over into the market as a whole? A handful of urban foodies aren’t going to alter broader industry trends that much, are they? That’s the question that’s been driving many industry-watchers for years, and the conclusion of many appears to be leaning towards yes. And one of the primary factors pushing them that way is the success of higher-quality fast-casual restaurants.

Chipotle (CMG) Leading the Way

One of the most interesting stories in this regard is Chipotle Mexican Grill (CMG) , regarded by many as a benchmark for this new breed of fast-casual restaurant. And it’s not without irony that Chipotle’s success was made possible by McDonalds, which began investing in the Denver-based chain and its 16 locations in 1998 after it had been in existence for just five years. By 2006, when McDonalds divested itself from the company, it had over 500 locations across the country and McDonalds had turned its initial investment of $316 million into $1.5 billion. A tidy profit that came as McDonalds was making an effort to divest itself of all its other holdings to focus on its core business.

However, it may be Chipotle that has the last laugh. Coinciding with the relative stagnation of McDonalds shares has been a meteoric rise for Chipotle’s. Since reaching a 52-week low in October of last year amid shareholder lawsuits over potentially misleading statements from the restaurant’s leadership, shares have exploded to the tune of an over 70 percent gain since November 1, 2012.

And it’s not hard to see why Chipotle is so popular. In many ways, the traditional fast food industry, long a bastion of the convenient and inexpensive meal, has been exposed. Because Chipotle’s offerings manage to remain relatively inexpensive ($6.50 for a chicken burrito) while offering a product made with fresh ingredients that offers clearly superior quality. And this comes without a tremendous disadvantage for Chipotle in terms of convenience.

Not Your Grandfather's Fast Food Restaurants

If Chipotle were the only new face on the block, McDonalds really wouldn’t have much to worry about. Personal preference can’t be defined clearly, and for every person more than happy to pay an extra dollar or two and wait in line an extra few minutes for fresher, higher-quality food, there’s bound to be plenty who just don’t like burritos. Or just prefer McDonalds. However, Chipotle may be the most visible company in this segment, but it’s not alone.

Noodles & Co. (NDLS) held its IPO on June 28 and saw shares immediately skyrocket just under 30 percent over the next two days. The company, which serves a wide variety of noodle dishes from around the world for prices as low as $6 a bowl, has lost some ground since its peak but remains 20 percent over its IPO value. Panera Bread Co (PNRA) has struggled over the last year, but is still up almost 250 percent over the last five years. Potbelly Corp. ($PBPB) shot up after its IPO on Friday and has settled into gains of 5 percent after its second day of trading. And Chipotle’s re-entering the space with its second chain, the Asian-themed Shop House.

And with more and more options available, customers have a lot of variety in their choices, potentially drawing away even more of McDonalds’ potential customers. And for those observing that none of these companies is directly challenging McDonalds in serving burgers and fries, the privately owned Five Guys Burgers and Fries has, since beginning to franchise locations in 2003, expanded from six to over 1,000 locations in the United States and Canada with another 1,500 in development in just nine years, making it the fastest-growing fast food chain in the country. The formula for success? Once again, higher quality than traditional fast food at higher-but-still-competitive prices.

A Sign of Things to Come?

It’s clearly more than a little premature to begin writing an obituary for McDonalds. It is, after all, a $94 billion company. While it would be hasty to claim that American palettes have moved, even if it weretrue, the globalization of the brand means it would still be in a strong position. The same can be said for YUM! And, once again, a lack of growth in share price over a two-year period is hardly a reason for panic, especially when the company’s offering a healthy dividend.

But it’s hard to ignore the cultural shift in eating habits that appears to be taking place completely. And the success of chains like Chipotle or Noodles & Co., with an entirely new approach to the business, could mean that the casual dining segment is about to enter a stage of relative flux that could change the way even the giants do business.