Chipotle Mexican Grill, Inc. (NYSE:CMG)
Raymond James Institutional Investors Conference Call
March 5, 2013 11:00 AM ET
Steve Ells – Chairman and Co-CEO
Monty Moran – Co-CEO
John Hartung – CFO
Bryan Elliott – Raymond James
Bryan Elliott – Raymond James
I’m Bryan Elliott, the Restaurant Analyst here at Raymond James, and happy to have as one of our restaurant companies, Chipotle Mexican Grill, which has put up the single best 10-year track record in the history of the restaurant business, which may be the world’s second oldest profession. I’m still doing research on that, but very, very powerful story.
So representing the company, Chief Financial Officer, John Hartung; President and Co-CEO, Monty Moran; and leading off the presentation, Founder and Co-CEO, Steve Ells.
Good morning, everybody. I want to remind you that our presentation today may include forward-looking statements and, as you know, actual results may vary. This slide gives you information regarding these forward-looking statements and where to go to get information about risk factors.
With that, so this year marks Chipotle’s 20th anniversary, and of course, I’m proud of our many accomplishments over the years. But more importantly, I’m excited about our potential to continue to change the way people think about any fast food.
What started out as a pretty simple idea – Monty, if you could shut off your phone, please. Thank you. So it doesn’t mean it has to be a typical fast food experience, and that has turned into a national brand. We’re serving almost a million customers every day, and we’ve rewritten fast food rules, sourcing more and more sustainably-raised ingredients, respecting farmers and the environment, animals and, ultimately, our customers.
We’re looking also to maintaining our commitment to preparing all of our food using classic cooking methods. Together, these things are the cornerstone of our food culture, allowing us to serve great tasting food made from sustainably-raised ingredients.
We’re also creating a culture of top performing crew members and managers, who are empowered to achieve high standards, really some of the highest in the industry to become the future leaders of our company, and we’re building exciting restaurants with an eye not only to pleasing aesthetics but with more efficiencies both in the dining room and in the kitchen. We’re using equipment that’s both more powerful and efficient while using less energy and less space. And what’s really exciting is that we’re proving that this is not just a model for burritos and tacos. But for other types of cuisines as well as seen by the success of our ShopHouse Restaurant in Washington D.C.
Our marketing this year’s going to continue to focus on building the Chipotle brand. It will also, however, include heavier emphasis on driving traffic and encouraging trial than it did in years past. Marketing programs this year are going to include a significant ad buy in 25 Chipotle markets including Los Angeles, Chicago and Washington D.C. These ad buys including radio, print and outdoor will take place before the end of the first quarter and will end by July or near the end of the summer depending on the specific market.
In addition, we’re also going to have significant well-developed local sales building plans in many of our best markets. The new marketing effort represents an evolution from talking about ingredients to talking about food preparation, and how our food is skillfully made and the precise way we bring our food to life.
In addition, this marketing effort will emphasize the beautiful and colorful images of our food that we serve and highlight the superior quality of the taste and ingredients. Our marketing efforts will also strengthen our brand and develop a deeper relationship with our customers through our successful non-traditional marketing techniques. This year, we’re going to continue to build on our signature Cultivate event series by hosting the events in Chicago, Denver and San Francisco, and following up last year’s successful Back to the Start animated short film, we’re developing new content programs that will continue to strengthen the Chipotle brand and that will spark conversation about important issues relating to food.
We have a few exciting initiatives underway that you may have heard about. We’ve introduced catering, which was rolled out in mid-January in the Colorado market, which represents about 70 restaurants. Catering is offered to customers in groups of 20 or more, while Burritos By The Box option is available for smaller orders of six or more. It’s been exciting to see people enjoy catering for the first time when they realize they have a chance to come in and experience the typical Chipotle line only in a smaller version, where they serve themselves and customize their meals and get exactly the kinds of combinations that they want.
In the Colorado market, print, radio and online advertising is helping to build customer awareness around catering and our Colorado restaurants also feature a catering menu panel on the menu board to increase awareness. And so far, the order size is over $300 and the early feedback has been positive, including many customer requests to expand catering to additional markets. And so we look forward to a phased rollout of catering in all of our markets across the country in the coming months.
This is Sofritas. We’re currently testing this delicious and flavorful vegetarian offering in our San Francisco Bay Area restaurants, actually only seven of them right now. Sofritas is shredded organic braised tofu with roasted tomatillos and poblanos, roasted chili peppers and a blend of aromatic spices. The early reaction and customer feedback has been really positive and press and media attention leading up to the launch also helped to get it off to a good start. We’re going to explore rolling this out to additional markets in the coming months based on the continued testing and additional customer feedback and we’ll keep you appraised of the progress, as we continue to look at how it goes.
We continue to plant seeds for future growth opportunities with our international expansion and with ShopHouse. Currently, we have 12 international restaurants and one ShopHouse. Of our international restaurants, five are in Canada, where we started almost five years ago; six in London where we started over two years ago; and one in Paris, which just opened last year. In 2013 or later this year, we’re going to add our first restaurant in Germany.
Our focus for our international expansion has been on introducing the Chipotle brand, establishing relationships with like-minded suppliers, and developing leaders to support our expansion. Each of these 12 restaurants and ShopHouse represent growth options that have – that we have planted in our part of our portfolio strategy that allows us to introduce the Chipotle brand in new markets while the majority of our new restaurants are opened in proven markets, where the returns are high and more predictable. In evaluating the success of these various growth options, so far we are most pleased with the success of Canada and of ShopHouse.
ShopHouse continues to perform well and reminds me a lot of the very first Chipotle when I opened it 20 years ago. Customers immediately noticed that it’s very different from the typical Asian offering out there, much in the same way they noticed that Chipotle was different than their typical Mexican restaurant experience. And I’m encouraged and excited about the potential because of the strong customer loyalty that we’ve started to see.
I think it’s already showing that Chipotle’s long-term potential isn’t just about burritos and tacos, but rather is about the possibility of serving great-tasting food made with great quality sustainably-raised ingredients using classic cooking methods, and served in this interactive format. We’ll leverage our top performing field teams to open the second and third ShopHouses that are under construction now in Washington D.C. and in Los Angeles, both of which are slated to open during the first half of this year.
So while we’re excited about the prospect for ShopHouse and for Chipotle internationally, the primary driver of our growth for the foreseeable future will be building Chipotles in the United States.
I’ll turn it now over to Monty.
Thank you, Steve. Steve mentioned that our food culture is a key driver of our success and the other key driver of our success is our unique and exciting people culture. At Chipotle, we’ve designed a culture that appeals only the top performers and actually repels low performers. The key principle of this culture is that we reward and elevate our leaders in Chipotle based upon their ability to make the people around them better. So the foundation of this culture continues to be our restaurateur program, which is a group of elite managers who are selected by the officers of Chipotle based upon their ability to create top-performing teams, who are empowered to deliver very high standards and great restaurant experience.
So in many respects, one can judge the health of Chipotle based upon the health of our people culture, based upon the number of general managers who are becoming restaurateurs and people who are able to reach that elite position. So this graph just shows the amount of restaurateurs over time, including those folks who have moved into field leader positions such as apprentice team leader, team leader, and team director. So in 2012, our number of restaurateurs increased over 57% in a single year. Demonstrating their field leadership is becoming more and more capable of explaining to folks and teaching folks how to create these elite restaurant level – restaurateur level cultures, and delivering fantastic dining experiences.
At the end of 2012, we had 422 of these elite managers and when you consider and including the field leaders who have come up to the restaurateur program to reach multiunit positions, such as apprentice team leader, team leader and team director. This group is now overseeing directly or indirectly over two-thirds of all of Chipotle’s restaurants, which is very exciting to us. So an important and ongoing goal and focus of ours was going to be to accelerate and continue to accelerate and expand our restaurateur culture, which will allow us to open more restaurants and be confident for they’re going to be well run and operated according to our very high standards.
Empowered cultures create excellent teams and these excellent teams are exciting, productive, and powerful. They attract great employees and develop them to be at their very best, and they grow leaders from within the organization, which not only supports our operations but also supports our growth and makes it sustainable as we add more restaurants.
At Chipotle, we define empowerment as meaning that our crew is confident in their ability and encouraged by their circumstances such that they feel motivated and have liberty to fully devote themselves to running great restaurants. We’ve been working hard to develop a field leadership team, which knows how to create these empowered restaurateur cultures quickly. More and more of our field leaders now come from restaurateur those who have internally move their way up through the ranks, which is terrific news. Our focus is to help these leadership teams create these restaurateur cultures quickly. Reverting the time is not a key factor in the development of a restaurateur candidate. It can happen very quickly and that makes us optimistic about our ability to attract and develop future leaders to support our future growth.
It’s incredibly satisfying to see – for us to see what a high performing empowered team of restaurant managers and crew can accomplish. And our restaurateurs continue to surprise us and exceed our expectations. They actually show us as a management team what’s possible for Tripoli rather than the other way around. They run lower labor costs. They run lower food costs. They lower the amount that we spend on maintenance and repair. They develop techniques in order for us to increase our throughput. They increase our comp sales in our restaurants.
And they run better margins because of their stronger teams are more efficient, and essentially they get more done with less resources and they deliver very high standards in our restaurants and create a great dining experience, which keeps demand for what we do very, very high and that demand is what allows for us to continue with our accelerated growth in new store development.
So on the subject of new store development, it is the strongest we have ever seen. We’re building more restaurants now than ever before while at the same time managing our investment costs very efficiently. We’re proud of our simplified restaurant design and the better atmosphere it creates for our customers and our employees and these new restaurants are also opening at tremendous sales volumes and great returns on our invested capital.
We’re also finding a lot of great real estate, which allowed us to open 183 restaurants in 2012. And we’ve also given guidance that we plan to open between 165 to 180 this year in 2013. We’re also continuing to see a slight recovery in new construction activity with landlord built centers and pad locations recovering more quickly than large scale shopping centers. At the low point in 2010, about 30% of our deals were new construction projects and we expect that that will increase to about 40% in 2013 with potentially greater increases in the future.
In 2013, nearly 20% of these new openings – of already openings will be A models, which are fully functioning Chipotles, but where we have lowered the occupancy cost, lower operational cost and also lower development costs. This A model strategy has really helped us to find more real estate, while providing attractive returns with lower operating costs and lower investment costs required in our traditional store formats.
So with that, I’ll turn it over to Jack.
Thanks, Monty. Just a recap of our results for the full year 2012. So, I wanted to review those quickly. Our revenue for the full year was over $2.7 billion for the year. That was up a little more than 20% over 2011. Our comps for the year overall were 7.1%. Restaurant level margins were the highest margins we’ve ever had at the restaurant level of 27.1%. That was an increase of 110 basis points compared to 2011.
Diluted earnings per share were $8.75 and that’s an increase of 29.4% and that’s a nice relationship, that we’d like to see where we have sales growing at 20% and then our EPS growing at a much higher rate, nearly 30%.
We opened 183 new restaurants during the year. Our total restaurant count at the end of the year was that 1,410. And just to reiterate our guidance that we gave at the time of our fourth quarter earnings release, we expect next year to open between 165 and 180 new restaurants. And we’re expecting flat to low single-digit comps for the full year.
Our revenue growth has seen steady growth over the last several years. Our sales in 2012 at over $2.7 billion is more than triple what we saw in 2006. That was the first year that we’re a public company, and we added – just in the last year alone, we added over $460 million in sales, which is in the same ballpark of the last company – the last year that we were a private company in 2005. So just in one year, we’re adding a substantial number of new customers, substantial number of new sales each and every year.
Our average restaurant sales have grown significantly over the years. We’ve grown our restaurant count from just under 1,000 back in 2009 to over 1,400. That’s nearly a 50% increase in our restaurant count. But at the same time, our average restaurant, those are restaurants that are open at least 12 months or more, while we’re adding to the base is still being growing from just over $1.7 million to over $2.1 million in 2012. And this has a substantial impact on our unit economics, our margins, and our returns.
In fact, looking at margins, I mentioned that the 2012 margin of 27.1% at the restaurant level, that’s the highest margin we’ve ever had. And that’s despite seeing some inflation hit us in the fourth quarter and the inflation we saw in the fourth quarter on our food was a little higher than expected, and yet we still were able to generate these very, very high restaurant level margins at 27.1%.
Our company operated margins have grown from just over 13% in 2009 to nearly 17% in 2012. And there’s no company-owned restaurants that we know that have restaurant level margins in this kind of ballpark. In fact, this kind of margin is at or above the restaurant level – or the operating margin that you see of a franchise company. The difference is our margins on total top line sales versus the franchise company is only in the fees that they collect.
This is what our unit economics look like. So when our average restaurant today stands at $2,113,000 and at restaurant-level margin of 27.1%, we generate average cash flow of about $572,000 at the restaurant level. Our new restaurants cost about $800,000. And so our returns for a new investment existing restaurant is about 71.5%.
Our new restaurants don’t open up at this $2.1 million. They open up – our guidance range for openings has been in the $1.5 million to $1.6 million range. For the last couple of years, our restaurants have been opening at or above the high end of that range. So within just a few years of comp, we fully expect that our new restaurants will either hit or approach this $2.1 million. And so we expect that our new restaurants are going to open up and within a few years approach or hit this 70% or greater return on investment.
Our business generates a lot of cash. In fact, last year we generated nearly $500 million in cash, $493 million to be exact. Of that nearly $500 million, over $400 million of that was reinvested back in the business, about $200 million or just under $200 million was reinvested in new restaurants, keeping up our existing restaurants and a few other corporate initiatives. We have the largest stock buyback we’ve ever had in our history of over $200 million. So those two combined represented an investment back in our business of over $400 million. And yet we still were able to add to our cash balance of $80 million.
So with that, I think, Bryan, do we have a few minutes to open up for questions? Okay. Be happy to answer any questions that you might have.
Well, what we said...
Bryan Elliott – Raymond James
Repeat the question for the webcast.
Okay. The question was about pricing, what we have to see or not see in order to take pricing or not take pricing. We’ve been pretty consistent with this. We’re open to the idea of menu pricing. We saw inflation hit our food costs more than we expected in the fourth quarter. We’re open to the idea.
I wouldn’t expect to see anything before the first half of the year and we look at a number of factors. Inflation is just one of the factors and it’s not even the most important factor. We’ll look at things like the strength of the economy, the strength of consumer confidence. We’ll look at our transaction trends. We’ll also go and look at market by market, look at what our menu prices are compared to our competitors.
Our sense, even though we haven’t updated that market by market, our sense is that we do have pricing power. It’ll be two years mid-year this year before we’ve had a price increase across most of our markets. So we think that we have pricing power. But those are the factors, generally, that we’ll take into account.
And we’re not going to rush into it; we won’t be in a hurry. We’ve always been a company that’s been more patient then others. We don’t have to rush into a price increase. We have very high margins, very high returns and we don’t have franchisees who are aching to increase prices because they’re worried about making their debt payment or they’re worried about increasing their cash flow. So, but we’re open to the idea of a price increase, but not before mid-year.
At the end of the fourth quarter. Are you guys beginning to see that trend?
We haven’t given and we’re not going to give an update on what we’re seeing in the first quarter. We’ll do that in April when we release the first quarter results. But I’ll just reiterate what we talked about in the fourth quarter when we had our earnings release last month.
We had higher than expected inflation during the fourth quarter. Some of those items we had already seen retreating and so we had in December, for example, we had lower food cost in December than we did in November. And so we did see a little bit of a retreat. That’s why it gave us confidence that although our food cost didn’t move up higher than we thought in the fourth quarter of 33.5%, we did expect to see some additional inflation. We thought there’d still be some inflation on the meat, some inflation on the dairy. Again, no update. We’ll give a full update in the first quarter. But even with modest inflation, we thought our food costs would still stay around that 33.5% or so.
When you’ve done your competitive analysis are you priced at a premium to competition and, if so, how much?
Okay. The question was when we’ve done our competitive pricing, have we been priced at a premium? We haven’t updated it, but generally when we done it, and we have other analysts that are doing it like Wall Street analysts that we’ll do it from time to time, and they’ll do it more across the company compared to certain competitors. We usually, we’re not premium priced. We should be premium priced.
Okay, we spend a lot more in our ingredients than anybody else out there and when you compare our menu prices to other fast casual or burrito companies that are serving something similar but not nearly the same quality or not nearly the same cost that we invest in our ingredients, our prices are comparable, and often our prices are a little bit lower than theirs. And so that gives us a lot of confidence that we do have pricing power. But we’ve been very, very careful and thoughtful before we go ahead and spend that pricing power. Keep in mind, one of our vision is to change the way people think about and eat fast food.
One of the important tenets of that is to be accessible, and so we want Chipotle to be affordable. We don’t want to charge such a premium price such that people can only enjoy Chipotle occasionally or that it’s a little more expensive. And so they won’t visit us often and so we’ve worked hard over the years to make sure our model works so that it’s really efficient. So we can generate very high returns, we can charge a reasonable price and yet still continue investing in very, very high quality, expensive ingredients. And so, but that studies we have done, though we haven’t updated it market by market, generally shows that our pricing is about the same. And oftentimes less than other fast-casual providers. Yes, sir.
Steve or Monty, you want to talk about share trends? I’m just kidding. We don’t really look at share trends by market, to be honest. What we look at is we look at things like what are our transaction trends. We’ll do research about what’s the awareness of Chipotle, what’s the appreciation of Chipotle. We’ll look a lot more at our teams like we’ll go into a market where we have great share. We were in a restaurant yesterday that was phenomenal in terms of share. It was much higher than average volume. We found lots of things that the team was doing that they’re getting a lot better.
And so we’ll spend a lot more time looking at what the opportunity is for us to get better – better in terms of the team, better in terms of the leadership, better in terms of the way we’re serving our customers because we know we’ve got lots of opportunity to get better in every single way and then we’ll capture more than our fair share. But we don’t do a lot of studies in terms of individual market share in every market.
Somebody’s got to ask a question for Monty or Steve so they can get out of their chairs so.
Well, again, we’re not going to comment specifically about the 2% pricing, but oh – okay, the question was about the consumer behavior has been a little bit uneven some have been affected recently by things like the 2% payroll tax increase and how do we adjust for that.
The bottom line is we don’t adjust for that. Those are cyclical things. Those are things that come and go. We focus on having a great food culture where we go and buy the highest quality ingredients we can find. We focus on the way we prepare our food, so that we can prepare a delicious meal for our customers. We focus on our people culture in every single restaurant. We run all of our restaurants, all 1,410 of them.
And so we focus on the kind of leaders that we’re developing, the kind of crew that we’re hiring. Do we have future leaders in these restaurants? Are they empowered to create a terrific experience? If we do all that, Chipotle is affordable. Okay. It’s not that expensive to go enjoy Chipotle. And so, generally, in the past when we’ve had little economic hiccups, we’re not the first ones to be affected. We’re not immuned from the economic malaise that you see from time to time.
But generally, Chipotle is pretty high up in consumers’ budgets. They’ll cut things out before they get to Chipotle because we’re not that expensive and they really enjoy the experience. They feel good about the value. We have very, very high value scores where customers come to Chipotle and feel like they get a great meal. And value scores are not just based on price. A lot of fast food, their value is driven by price. It’s a $0.99 this, it’s a $3.99 or $4.99 that. Most or all of our value is based on the quality of the experience, the quality of the food, the foods made before them. They know it’s freshly made. They know it’s high quality.
And so our customers attach a very high value to their experience at Chipotle and so, generally, that’s what we focus on, and we know that through these ups and downs of the economy, that’s what’s kind of bode well. We would never be a company that would take some short-term action based on something cyclical or some kind of temporary effect in the economy. Yes, sir.
Excellent. Okay. I thought you had one for Steve. It’s typical. The supply chain that exists today for Chipotle didn’t exist 10 years ago, and so we had to work with each of our suppliers. We’ve had to help our or allow our suppliers to grow with us and grow in an intelligent way. We’ve had to bring additional suppliers on. There have been times where we have temporary supply interruptions, where we will have in a particular market for a few days or a few weeks where we run out of naturally-raised chicken. And so we’re kind of always pushing the edge. We’re confident that this supply will continue to grow with us.
Consumers are more and more curious and more and more discerning about where their food comes from. The more they learn, the more we think that they’ll appreciate Chipotle, and we think that the more that they appreciate things like that, other companies which they’re already doing this are moving towards this trend, if you will. It doesn’t feel like a trend. It feels like a sea change where other companies and other consumers, they do care more about where their ingredients come from.
And so it’s hard, it’s a constant battle, but we continue to work with our suppliers, so that they’re a little bit ahead of us. So that we can continue to open up the restaurants that we’ve guided and still supply these very special ingredients that we buy. Yes, sir.
If we had Monty up here, I think he’d answer it this way. The question is about our real estate portfolio and how much is leased versus buy. Most of our property is leased. If you go around Chipotle, you’ll notice the vast majority, probably about 80% or so of our restaurants are in somebody else’s building where we’re one tenant and then there’s a bunch of tenants.
We do have a handful, 15% or 20% of our sites are free standards. Even those we own a very small percentage; maybe we own 10% or so of those. It’s not that we wouldn’t buy. We’ve got lots of capital. We’ve got a very low cost of capital. So we’re certainly interested and would be willing to invest in buying the land, buying the building. It just so happens that the most attractive opportunities, in most cases, from an overall standpoint position in the market, unit economics, investment, et cetera, tend to lean towards more leased property and so that’s what most of our sites are in.
Well, the market balancing out a little bit more, but I’d say it’s been balanced for a few years. I think there was about a year-and-a-half-or-so period there where it was opportunistic, but most of the opportunity when we saw opportunities to push leases down or to negotiate lower rents was in lesser quality real estate.
Generally, in the A property, in the very attractive real estate, generally, those landlords would hold to their rents and so there was maybe year-and-a-half opportunity where the rents were more negotiable. And I would say they’re stabilizing and may be moving up a little bit now, but nothing in an extraordinary way. I’d say the rents that we’re getting, that we’re paying for compared to our economics and the sales we expect have been pretty attractive still.
Bryan Elliott – Raymond James
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