Americans spend approximately $680 billion per year on fast food. The fast-food industry has grown at a staggering pace over the past few years and is expected to sustain its upward trajectory. While the fast-food market is growing, health awareness among people is also increasing. A fundamental shift is occurring in the food industry as many people are opting for healthier food. Thus, it doesn’t come in as a surprise that the U.S. organic food market is expected to grow at a CAGR of 14% till 2018.
One company that is nicely positioned to benefit from both these trends is Chipotle Mexican Grill (CMG, Financial). Chipotle has been a great growth stock for investors over the years and is still going strong.
Chipotle has performed extraordinarily over the last 10 years. Its sales have grown from under $630 million in 2005 to over $4 billion in 2015. And it doesn’t look like this trend will end soon as the company’s revenue grew 20% in the last quarter as well. Also, the company has a lot of room to grow as it aims to open 3,000 restaurants in the U.S. alone. So, I think investors should use Chipotle’s underperformance to buy the stock, and it offers significant upside potential.
GMO-free food will attract Millennials
Chipotle’s “Food with Integrity” policy has always gone down well with the customers, and the company will abide by it to propel growth. Chipotle recently announced that it has become the first fast-food company to use only non-GMO ingredients. The company will stop serving food that has been genetically modified, further enhancing the dining experience for health-conscious customers.
I think it is a great decision and will help the company benefit from the increasing health awareness among people. While the FDA hasn’t deemed the use of GMO food dangerous to human health, many reports suggest that it is not healthy. In fact, many countries have even banned GMO food. With long-term health implications of GMO food still in doubt, I think Chipotle will gain customers by going GMO-free.
According to a study by Nielsen, GMO-free food is considered “very important” to 43% of the people. That outranked concerns regarding lower calories, artificial flavors and those looking for gluten-free alternatives. Younger consumers are willing to pay a premium for high-quality food as Nielsen claimed that 29% of the surveyed Millennials are “very willing” to pay extra for healthy foods.
Millennials comprise about 25% of the U.S. population and hold roughly $1.3 trillion in spending power. Millennials will be an important growth driver for many restaurants, which is why I think going GMO-free will benefit the company in the long run.
Pricing power
The U.S. economy is getting stronger as the unemployment rate has plunged from roughly 10% in 2010 to 5.5% in 2015 and is forecast to remain at this level for another year.
In addition, oil prices have also dropped to under $3 per gallon and are expected to stay at this level until 2016. These factors bode well for Chipotle as people in the U.S. have more disposable income and are more likely to spend as compared to previous years.
Chipotle possesses more pricing power than other restaurant companies and had an average check of more than $10 per customer in the previous quarter. Customers are willing to pay a premium for Chipotle’s quality-assured food as the company has increased menu prices for the last five years consistently. Now that the company is going GMO-free, it can further increase menu prices to boost margins.
Valuation
Chipotle is currently trading at 34x forward earnings and has a P/S ratio of 4.37. While the valuation may look expensive, the company can easily justify it on the back of sustained financial growth. Bearing in mind the growing demand for healthier food and the fact that Chipotle still has room to open many new stores, it can easily sustain double-digit revenue and earnings growth for the coming quarters. The company has an estimated sales growth rate of 15.51% for 2015, which is more than twice the industry average of 7.43%. In addition, its net margin of 11.30% is also considerably higher than the industry average of 4.64%. Thus, given the growth prospects, I think Chipotle can easily justify its lofty valuation.
Conclusion
While investors will have to pay a hefty premium to own Chipotle’s stock, I think Chipotle will prove to be a rewarding investment in the long run. The company is perfectly positioned to benefit from the growing fast-food and organic food market and has loads of room to grow. Chipotle can still open over 1,100 stores in the U.S. alone and will also expand internationally in the years to come.
The company’s growth prospects are strong, which is why I think it deserves a premium valuation. So, I think investors should use Chipotle’s underperformance to buy the stock.
