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Chipotle: Not Cheap but Taking a Leap

March 06, 2014 | About:
Victor Selva

Victor Selva

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Chipotle Mexican Grill Inc. (CMG) is one of the largest players in the quick-casual Mexican restaurant category, operating in 43 states throughout the U.S., as well as in Canada, the UK, France and Germany. Chipotle offers a broad menu which includes burritos, tacos, burrito bowls and salads made from high quality ingredients such as hormone-free pork and natural chicken, and by choosing from four different meats, two types of beans and several extras allows more than 65,000 menu combinations. As of December 2013 Chipotle Mexican Grill Inc. operated 1,595 restaurants globally.

Although Chipotle was always regarded as a company with a revolutionary and innovative approach to fast-casual dining, the fact that it had only one restaurant brand bothered investors. Well, now it seems this only-brand company is changing, as it announced the release of two new restaurant brands focused on entirely different cuisines: ShopHouse and Pizzeria Locale.

The Chipotle Mexican Model

Among fast-casual Mexican restaurants, Chipotle is no doubt one of the top restaurant chains in the U.S., offering freshly prepared food in an attractive environment with an open-view kitchen and a distinctive and stylish aesthetic. The company’s strategy of doing few things but doing them very well allows it to grow and manage heavy volumes of traffic. Although its P/E is actually 55.6, almost more than twice the industry average of 27.9, Chipotle has come to deliver exceptional same-store sales growth by constantly improving its operational efficiency

Chipotle Mexican Grill has accelerated its worth in one year nearly 75%, to a present value of $579. This figure is likely to keep up as this Mexican chief operates within a structure that allows the company to sustain its growth. As we know, this industry is constantly pushing companies to expand, generate traffic and develop innovations in order to compete with their peers. Chipotle has a highly leverageable model which continues to deliver margin gains, and showed exceptional fourth-quarter comps of 9.3%. One of the most impressive things of this comp growth is the fact that 8% of it was driven by transaction gains, exceeding the average comps among U.S. restaurants around 2% to 2.5%. New restaurants opened during 2013 have been operating above the high end of management’s $1.6 million to $1.7 million average unit volume target. This performance has led many analysts to believe Chipotle is standing over solid ground, and its growth is yet likely to increase.

Indeed inflation has pushed some prices and took a bite on restaurant’s revenues. Nevertheless, Chipotle has managed to transfer these costs to customers with variations on menu prices; the effect of the increased costs of production isn’t affecting severely its net income. Chipotle prides itself on using premium quality ingredients, and customers have come to accept the modest price adjustments. Furthermore, the fact that the company obtains most of its naturally raised and organic products from local ranchers and farmers allows it to keep more control than similar sized companies over its suppliers.

Chipotle’s Organic Food

It’s no news consumers have started to incline towards healthier diets, choosing organic ingredients over processed ones. Companies in the restaurant industry have been dealing with this tendency for some years now, and Chipotle is one firm that has had considerable success bending towards this market shift. Already selecting organic meats and cooking with organic oil, this year it expects to eliminate harmful ingredients from its flour and tortillas. Chipotle is developing as well a marketing campaign against GMO food, and has recently rolled out the “food with integrity” mission, as a part of Chipotle’s “scarecrow” marketing program. In this line, Chipotle recently introduce a tofu menu. Although directed towards vegans, Chipotle’s Sofritas, as they call the new tofu-burrito, has had some unexpected response, as it has been chosen by many non-vegan customers as well. The combination this company has pulled out between organic food and heavy advertising is likely to allow Chipotle to sustain top-line growth.

New Brands

Despite the uncertainty of the macroeconomic environment, Chipotle has been expanding over the past years. In 2013 the company opened 185 restaurants, reflecting net unit growth of 13%. The brand has now a stable recognition among customers and stands firms amid this highly competitive industry. Indeed the company has yet to explore international markets, operating only 16 restaurants outside the U.S., but its presence in the American market is growing bigger each year.

Chipotle is introduced during 2011 the ShopHouse, a Southeast Asian Kitchen concept, inspired on the Vietnamese-Malaysian traditional shophouses. Offering a variety of typical Asian cuisine dishes, the ShopHouse has opened in Washington DC and California, and is expected to expand. The other brand Pizzeria Locale is still developing, and Chipotle expects to release its new concept in the near future.

What to Expect

Fast-casual restaurants are growing while the big chains are struggling to adapt to the new market tendencies. The competition is beginning to be fiercer among these smaller restaurants, growing nearly 10% during the next few years because of a compelling consumer value proposition. Chipotle offers a promising scenario. Some analysts think the company is likely to outgrow this fast-casual category, but remain with a less capital-reliant restaurant prototype.

Nowadays Chipotle has pricing power and a strong brand recognition that fends off rivals. The company posted strong fourth-quarter 2013 results for both earnings and revenues. Comps grew year over year to 9.3%, led by higher traffic. The new menu launches, marketing programs and increased media exposure are likely to sustain the revenue momentum. Nevertheless, management is expecting a rise in food costs that might pressure restaurants' margins. Those feeling bearish about this stock say Chipotle will be contending with unpredictable consumer spending trends, wage increases and volatile commodity costs.

Despite the fact that the international market is yet to be explored and the macroeconomic uncertainty is always pushing income margins, Chipotle is one of the leader companies among the fast-casual dining industry, and one of the few that has taken full advantage of the green-food trend, gaining consumers' acceptance while meeting their expectations.

Disclosure: Victor Selva holds no position in any stocks mentioned.


Rating: 4.2/5 (6 votes)

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Comments

damianillia
Damianillia premium member - 5 months ago

Great analysis. I like the qualitative point of view, comprehensible for everyone. Thanks for the contribution.

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