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The Science of Hitting
The Science of Hitting
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A Stellar Year for Chipotle - And High Hopes for 2020

A look at the restaurant's 2019 financial results

February 07, 2020 | About:

Chipotle (NYSE:CMG) recently reported results for the fourth quarter of fiscal 2019.

Revenues in the quarter increased 18% to $1.4 billion, attributable to 5% growth in units (ending the year with 2,622 locations) and a 13% increase in comparable store sales (comps). The increase in comps was driven by traffic / transaction growth (8 points) and an increase in ticket as a result of menu price increases, a higher mix of premium offerings (including carne asada) and a higher mix of digital orders (which have a higher average check). As shown below, the company’s comp store sales growth has consistently accelerated over the past eight quarters.

For the year, Chipotle’s revenues increased by 15% to $5.6 billion, with the growth largely driven by an 11% increase in comps. The significant increase in revenues led to operating leverage, with restaurant-level operating margins up 220 basis points to 19.2%.

Non-traditional orders are driving meaningful growth for Chipotle. For the year, digital orders contributed $1 billion in revenues (~20% of the sales in the fourth quarter), compared to $250 million three years ago. As CEO Brian Niccol noted on the call, management believes there’s room for incremental digital mix: “We continue to see overall digital penetration for a Chipotlane restaurant in the high 20’s… So, we're delighted that we're around 20%, but that's not the end of this journey - that's just one of the stops on our journey to what I think will be a much bigger business than where we are today.”

Speaking of Chipotlanes (think of a fast food drive-thru lane, with the twist that orders must be placed online), the company added an additional 46 locations in the fourth quarter, bringing the total to 66 locations. In 2020, the company plans to open 150-165 units, with the majority of those having a Chipotlane. Clearly, management believes that this is an effective way to expand their digital business going forward. As I’ve noted before, I think this an interesting long-term opportunity that helps address one of the problems they face at busy locations: throughput.

As a result of mid-teens revenue growth and operating margin expansion, non-GAAP diluted earnings per share increased by more than 50% in 2019 to $14.1. While the stock certainly doesn’t look cheap here at $860 per share (roughly 60 times trailing earnings), it’s important to understand that there should be significant operating leverage if the company continues to deliver outsized comp store sales growth. As shown below, operating margins still have a long way to go to return to the plateau reached in 2016. As noted on the call, management believes that they should be able to deliver 25% restaurant level margins (or better) if average unit volumes increase to $2.5 million from $2.2 million today, implying nearly 600 basis points of margin expansion.

Valuation

As the results show, 2019 was a stellar year for Chipotle. That looks to continue in 2020, with management expecting another year of solid (mid-single digit) comp store sales growth. In addition, they’ve lit a fire under the digital business and have quickly built up a sizable rewards program since it launched in April 2019. Over the past six months, the number of enrolled members has increased by roughly 70% to 8.5 million.

But it seems to me that this is largely accounted for in today’s stock price. By my math, even if you assume continued mid-single digit comps, mid-single digit unit growth and more than 100 basis points a year of margin expansion (reaching 15% in five years), I end up with earnings in 2024 of roughly $40 per share. Said differently, the stock is trading at more than 20 times earnings five years out – and that assumes things continue to go as planned over that period (as we saw a few years back, that is far from assured). At that point, the company would have 3,500 locations, or roughly 70% of what they've previously communicated as their addressable market opportunity at home (in 2016, the company said they believed there was “potential for 5,000 Chipotle’s in the United States”).

That’s a long way of saying that I think there’s a fair amount of optimism embedded in the valuation at these levels. Now, if the company sees a step change in their business as the contribution from digital continues to grow, that could ultimately be justified. Personally, I think the price I’m being asked to pay for the chance to participate in that (potential) opportunity is too high. For that reason, I’m not interested in investing in Chipotle at current levels.

I’ll let Niccol have the last word:

“While Chipotle had an excellent 2019, what excites me the most is that we are just getting started. I believe we have the opportunity to continue to expand AUVs, margins, and store count over time… We're building a successful, durable model, and by staying focused on our priorities and executing flawlessly while providing customers with the unique Chipotle experience, I'm confident we will be successful for many years to come.”

Disclosure: None.

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About the author:

The Science of Hitting
I'm a value investor with a long-term focus. My goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio - a handful of equities account for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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