These restaurants are taking the lead on AI and robots. What it means for their stocks

Published Tue, Jun 4 20241:36 PM EDTUpdated Tue, Jun 4 20242:34 PM EDT

The artificial intelligence revolution is coming, and the restaurant industry does not plan to sit it out. Restaurants have traditionally lagged behind other sectors in their adoption of technology, but rising labor costs have changed the narrative. Major food industry players are making strides to invest in innovation, including AI and robotics. But when it comes to getting up to speed, certain companies are better poised to lead the pack than others, and it will likely affect the pace of growth they will be able to achieve. For instance, analysts on Wall Street say bigger players generally have the upper hand, both due to their vast resources and their access to major sets of consumer data. Due to the nature of their products, Chipotle and Sweetgreen are looking to establish a first-mover advantage when it comes to implementing robotics in their assembly lines. Ultimately, the structure of a company's business, such as whether it franchises or not, will also have a hand in determining the type of challenge it is trying to resolve through technological innovation. While it is still early days, analysts have already identified some companies that are taking the lead. The restaurant industry has historically underinvested in tech innovations compared to other industries, according to Bernstein analyst Danilo Gargiulo. He cited a 2016 study that revealed the average company across all industries will spend 8.2% of its revenue on tech investments, but the typical restaurant only spends 2.5%, putting the industry at the lowest pace of all 11 sectors studied. The gap can be blamed on three primary reasons: tight margins, the low cost of labor and a fragmented franchisee model that makes individual restaurant operators less likely to invest on expensive technology, Gargiulo said. However, the landscape is changing and is forcing restaurants to play catch-up. "Today, profitability pressures and [the] reduced gap between labor cost and tech costs are inducing restaurants to look for long-term solutions to restore their profitability; we believe AI will finally find its place in the restaurants' ecosystem," Gargiulo wrote in a report. 'One extra dollar' Although restaurants have lagged other industries in adoption, they are quickly catching up. It is fair to say that most restaurant chains are testing AI in at least one way, but the major players have an advantage over their smaller peers due to the sheer size of their resources, according to Morgan Stanley analyst Brian Harbour. "The biggest companies will have generally more capacity to invest in these sorts of things, especially where it could be quite expensive and it might lead nowhere," he told CNBC in an interview. Larger food companies have already made rudimentary advances to enhance supply chain processes. AI usage will likely focus next on applications such as marketing and voice recognition. Companies will want to reduce customer wait times and optimize the in-store experience by offering more personalized touches. However, the incentives for restaurants to invest may differ depending on their business models. For instance, large franchisors such as McDonald's are first and foremost dedicated to improving their top lines, since the parent company receives a percentage of every sale made. Franchisor-based companies will tend to invest to optimize the customer experience, so customers "spend one extra dollar every time they are coming to the store," Gargiulo explained. This can be done through using AI to increase the speed of service or personalize advertising to each customer or by region. As an example, Harbour pointed to McDonald's recent partnership with Google to individualize customer offers through AI optimization. The fast-food chain is also integrating AI capabilities into its kitchen equipment for predictive maintenance, he said. I think it's really a microcosm as to how this is going to increase the overall productivity of the global economy. Senior wealth advisor, Payne Capital Management Courtney Garcia On the other hand, nonfranchised chains such as Chipotle, Cava , Starbucks and Sweetgreen are much more focused on using automation to contain labor costs over time, thereby boosting their bottom lines. Starbucks has been focused on customizing its mobile app and automating inventory replacement to offload the task from managers. Chipotle is developing an operational monitoring system to alleviate bottlenecks and improve product throughput. Most importantly, the analysts agreed that where these top companies have a crucial advantage is their access to more consumer data. "Having more data will enable them to personalize more effectively and communicate to their customers, and that is going to incentivize the frequency and the behavior of the top lines," said Rahul Krotthapalli, an analyst at JPMorgan. For instance, Yum Brands , which operates KFC, Taco Bell and Pizza Hut, remains one of Gargiulo's top picks in the space due to its AI cross-functionalities. Since the company operates so many brands, it also has access to a mammoth supply of consumer data from which it can spot behavioral patterns. Yum has also invested a lot of time and money into acquiring or developing new technologies, analysts said. The company has not only built its own proprietary tools, but it has also partnered with or acquired other platforms such as Dragontail Systems , which optimizes the entire food preparation workflow; Agot , which uses computer AI vision to confirm order accuracy; and Collider Lab, a consulting firm dedicated to understanding cultural-based consumer patterns. "They've been on this path toward automation and general AI adoption that wasn't matched by others up until this point," Gargiulo said. However, most analysts covering Yum stock have assigned the name a hold rating, with the upside to average price target implying just a 5% rise. Shares of Yum Brands have added 6% so far this year. YUM YTD mountain Yum Brands shares year to date Robots peeling avocados, mixing salads The use of robotics in restaurants is at its nascence. Analysts say that so far, only two companies have made discernable strides toward adapting robotic technology — Chipotle and Sweetgreen. "On the in-store operations and automation sides, what Sweetgreen and Chipotle are doing is something that is directly applicable and will address the cost structure of these businesses and will help them expand margins," said Krotthapalli. Expanding margins generally increases a company's profits, which should theoretically lead to a higher stock price. However, given how early these companies are in adopting these newer technologies, it is still hard to say the exact financial benefits they might incur, Harbour said. "It's not something where I think you will see it in one quarter as big savings. But it gets progressively better over time, and hopefully, those that are deploying it most effectively should see a little bit of improvement in their economic model," the analyst added. Fast-casual Mexican chain Chipotle has teamed up with robotics kitchen company Hyphen to experiment with robotics in a variety of ways, including peeling avocados, assembling bowls and using a robot called Chippy to fry tortilla chips. Sweetgreen is attempting to automate its production lines to assemble salads after a customer places an order on a kiosk. "They're only in two stores right now, but are slated to roll out to more of them this year," Harbour said. He added that the company is already seeing "pretty substantial labor savings" in the test stores so far. Courtney Garcia, a senior wealth advisor at Payne Capital Management, also highlighted Mediterranean chain Cava as a stock to watch, although the company is a much smaller player. Cava, which just reported a first-quarter earnings and revenue beat , has recently begun to dabble in implementing automation in its kitchen processes, she said. Although Garcia voiced her bullishness, she does not own the stock outright, though Payne has exposure to both Cava and Chipotle in their exchange-traded fund holdings. Other analysts have been less enthusiastic about Cava shares given the stock's run. Both JPMorgan and Piper Sandler downgraded the shares to neutral from overweight last month. The stock has doubled so far this year, and at a relatively high valuation, JPMorgan prefers Chipotle, the bank wrote. Chipotle, Sweetgreen and Cava partially have an advantage due to the nature of their products, which offer customers a bowl of mixed ingredients as an end order. The type of food influences what can be automated, Harbour said. "Other companies have tested this, but we haven't really seen it go anywhere yet. As it turns out, making fries, making burgers, assembling a taco at Taco Bell is actually a pretty hard task. I don't think the robotics are quite there yet to be able to do that," he added. For Gargiulo, Chipotle's innovation in the robotics space has distinguished it as a clear leader. The company is one of his top picks for its focus on consumer trends and the simplicity of its operating model. Chipotle's business strategy is ultimately about enhancing labor efficiency rather than replacing workers altogether, he said. "They know that cutting the avocado is a painful process, so they are launching this auto-cutter machine. They know that cutting the fries and frying the chips is a tedious and sometimes dangerous process, so they are working toward implementing Chippy," Gargiulo noted. This, combined with the company's line process and bowls consisting of relatively few ingredients, should make these automated operations easier to scale up. "That's going to put Chipotle in a better spot versus other restaurants," the analyst added. Chipotle remains a crowd favorite on Wall Street, with more than two-thirds of analysts covering the name rating it either a buy or strong buy. The average potential upside for the stock is more than 6%, which would add onto Chipotle's 35% year-to-date rise. Chipotle's balance sheet puts it in a position where it can afford to invest in automation and AI, Garcia said. "They have nothing to do with artificial intelligence in their core business, but they're able to utilize it to increase their profitability," Garcia said. "I think it's really a microcosm as to how this is going to increase the overall productivity of the global economy."