As the most impressive breakthrough story in the restaurant industry, Chipotle Mexican Grill (NYSE:CMG) has been recording exceptional sales growth, as well as industry-leading margin levels over the past few years. With its winning combination of a uniquely customizable menu (over 65,000 available options, thanks to the vast assortment of meats and vegetables), and aesthetically pleasing diner venues, this fast-casual Mexican restaurant has won over the loyalty of its client base.
Although industry competition is very fierce, with rivals including Yum! Brands Inc. (NYSE:YUM), Fiesta Restaurant Group Inc. (NASDAQ:FRGI), and Jack in the Box Inc. (NASDAQ:JACK), Chipotle has managed to expand its venues to 1,600. Furthermore, the company benefits from international brand recognition, with operations in Canada, the UK, France and Germany, resulting in strong cash flow and pricing power. On another note, the firm has a differential value through its naturally raised and organic products, which has led to long term customer loyalty, as well as an expansion of the customer base itself.
So, in the article below, I will analyze Chipotle's past profitability, capital and operating efficiency, in addition to looking at which institutional investors have recently bought the company’s shares in the last quarter. Based on this information, we will get an understanding of the company´s revenues, operating metrics and quality of earnings.
Profitability is a class of financial metric used to analyze a business’ ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section I will study several profitability metrics, such as return on assets, quality of earnings, cash flows and revenues. By analyzing these four metrics, we will be able to elucidate if the company is really making money.
Operating Cash Flow
I always compare a company's revenue growth and operating cash flow growth, in order to get an accurate view of future profitability. Operating cash flow is the cash generated from the operations of a company — or revenue — minus all operating expenses (depreciation charges not deducted).
Over the past three years, the company's operating cash flow has increased by 29%, augmenting from $411 to $529. I advise to look for companies with strong cash generation profiles, as it is likely these will have a brighter future outlook.
ROA - Return On Assets = Net Income/Total Assets
ROA is an indicator of how profitable a company is relative to its total assets. It gives us an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. In simple terms, this metric tells you what earnings were generated from invested capital (assets).
I am encouraged by the fact that Chipotle’s ROA has increased from 16.88% to 17.81% in the past three years, because it indicates that the company is generating more from its assets than it did in 2010.
Quality of Earnings
Quality of earnings is the amount of earnings attributable to higher sales or lower costs, rather than artificial profits created by accounting anomalies — such as inflation of inventory. In order to assess Chipotle's quality of earnings we will compare the level of income with operating cash flows.
The company augmented its profits at a rate of 18%, but the growth of cash flows was higher. This is strong evidence of profits being created through a boost in sales. In fact, the $32 billion sales earnings achieved in 2013 make Chipotle the dominant player in the $7 billion domestic fast-casual Mexican restaurant category. Furthermore, the new Shophouse Southeast Asian Kitchen and Pizzeria Locale openings planned for 2014 should add to the company’s sales growth and revenue boost. Because these restaurant concepts require less capital and have lower occupancy costs, they should propel Chipotle’s profits in the long term, making this company a wise investment option.
Working Capital is a measure of both a company's efficiency and its short-term financial health. This ratio indicates whether a company has enough short term assets to cover its short term debt. Anything below 1 indicates negative W/C (working capital), while anything over 2 means that the company is not investing excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient.
Chipotle’s current ratio (working capital measurement) increased from 3.18 in 2010 to 3.34 in 2012. This shows that the company has a strong balance sheet and can pay off its obligations. Also, looking for companies with current ratios above one is a must for long-term investors.
Gross Margin: Gross Income/Sales
The gross profit tells an investor what percentage of revenue/sales is left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors —and overall industry — is more efficient. Investors tend to pay more for businesses that offer higher efficiency ratings than their competitors, as these should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).
Over the past three years, Chipotle’s gross margin has increased from 26.0% in 2010 to 26.6% in 2012. An increasing margin indicates that the company has, in fact, gained efficiency, hinting at a profitable future.
Asset turnover measures a firm's efficiency in using its assets to generate sales or revenue — the higher the number the better. It also indicates pricing strategy: Companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover.
The fact that this fast-casual restaurant's revenue growth has outpaced the assets growth (02% growth) on a percentage basis, indicates that the company is making money on its assets.
I feel encouraged by the fact that Jim Simons (Trades, Portfolio) and Steven Cohen (Trades, Portfolio) bought the stock in the past months at an average price of $486.73, since it shows that hedge funds have confidence in the stock.
Currently, many analysts have a good outlook for Chipotle. While analysts at MSN Money are predicting that the firm will retrieve EPS of $15.98 for fiscal 2014, sporting a 30.4% growth rate, Bloomberg’s analysts are estimating revenue jump from 2013’s recorded $3.2 billion to $4.40 billion for fiscal 2014, on target with the current 22.0% growth rate. However, on Sept. 18, 2013, Baird gave Chipotle a rating of "Outperform" with a target price of $579.35, signifying that the company may be somewhat overvalued at this point.
Although it still remains unclear how much profits Chipotle’s new secondary concepts will generate in the future, the company’s past financial results speak for themselves. In merely 20 years, this firm has managed to rise to the peak of the fast-casual restaurant category, with strong metrics in every aspect.
Apart from averaging a 27.2% EBITDA growth in fiscal 2013, the firm also sports an astounding 52% return on invested capital, which should be very attractive for investors. However, the high stock price might make this an unpropitious time of buy in the company’s shares, as it is somewhat overvalued. But once the price settles down, I think Chipotle is a definite win.
Disclosure: Damian Illia holds no position in any stocks mentioned.