In my last article, I looked at the public comparable companies to Noodles & Co. (NDLS). One insight gleaned from this analysis is that Chipotle (CMG) is leading the pack in virtually every important metric both operationally and financially:
-Sales CAGR from '10-'12 of 22%
-Store Count CAGR from '10-'12 of 14%
-2012 Restaurant CM of 27.1%
-EBITDA margin of 19.8%
-Leading per store Sales, CM, and EBITDA
-Leading return on investment from new stores
You can see how Chipotle compares to its peers in these metrics and others by reading my previous comparison article.
After completing the comparables analysis, it's clear that Chipotle is a market leader in their industry. At its current valuation of 20x LTM EBITDA, it's also trading for a premium compared to its peers, which are closer to 15x on average. Can the growth opportunities in front of Chipotle justify this multiple premium? I believe the answer is yes.
This article will analyze Chipotle's growth opportunities, apply assumptions to determine potential impact to EBITDA, and finally provide a conclusion on what the impact will be to Chipotle's stock price.
Opening new stores is a critical component of Chipotle's growth strategy. With a return on investment exceeding 70%, rapid store expansion is what we as investors want to see first and foremost. Chipotle has opened new stores at a 14% CAGR, and I see no reason why this will materially decrease over the next few years. Management has provided guidance to open another 165-180 stores this year. With 48 new stores opened in Q1, it appears Chipotle is on pace to hit the upper end of their guidance for the year, or perhaps even exceed it.
In addition to traditional new store openings, Chipotle has tailwinds in two areas, which help support its new store growth - A-model stores and ShopHouse.
On the last earnings call, Management acknowledged that they are more aggressively pursuing their "A-model" store opening strategy. A-model stores are smaller stores that have lower operating costs, but are still in highly trafficked areas. A prime example of an A-model store is the food court at a mall.
Chipotle has been generating a phenomenal 70% return on investment on new store openings. I see the A-model strategy as easily exceeding their previous 70% returns due to lower costs but comparable sales. The economics are so compelling that it begs the question as to why management has not pursued these A-model store openings sooner. My theory is that Chipotle has previously focused on building a premium brand, one that has effectively positioned themselves well above Taco Bell and other competitors in the Mexican food segment. Food court restaurants do not offer the ambience and culture of the traditional Chipotle store, so to open them previously could have weakened the brand positioning. This is very similar to how Starbucks (SBUX) built their brand and grew once it was established. Investors may not fully appreciate the earnings growth that these A-model stores can offer, which would not have been possible if Chipotle did not first establish their premium brand. Chipotle is now uniquely positioned to capitalize on A-model stores.
Management continues to test the ShopHouse brand with plans to get to 3 stores opened in the near term. While management states that their focus is on Chipotle and that ShopHouse is more of a test concept at this time, I believe that ShopHouse will provide another leg of the stool to fuel Chipotle's growth once growth in the Mexican market segment begins to decelerate.
Considering management's current view on ShopHouse, I think about it as downside protection if it becomes difficult to open new Chipotle stores. For this reason, I am not going to apply an estimated incremental EBITDA, but instead treat ShopHouse as a backup plan to achieve my expected store growth estimates.
New Store Growth - incremental 2016 EBITDA:
Overall, Chipotle should be able to keep opening new stores at double-digit annual growth rates. With 1,458 stores currently opened as of 1Q13, I believe Chipotle will have over 2,000 stores by the end of 2016. A realistic case is for Chipotle to have opened 2,200 stores by this time, which represents 742 new stores.
Applying the $2.1mm per store annual sales to the 742 new stores yields $1.6billion of annual sales from new stores opened by 2016. The EBITDA margin on these incremental sales should be higher than the company-wide margin of 19.8% due to fixed cost leverage and higher profit A-model stores, but likely lower than the Restaurant CM of 27.1%, so I will split the difference and apply a 23.5% EBITDA margin to the incremental sales, yielding an incremental EBITDA of $366mm.
Incremental 2016 EBITDA: $366mm
Chipotle has an average same-store growth rate of 9.2% from 2010A - 2012A. While Q1 came in a little light at 1% (3% on a holiday-adjusted basis), I believe that Chipotle will bounce back and have same-store sales growth rates closer to their historical numbers. Management has stated that they have held off on price increases until late summer / early fall. Once the price increases hit, this will boost same-store sales in the near term. Conservatively, I believe that Chipotle can achieve same-store sales growth of 6% per year on average through 2016.
That would provide $717mm of incremental sales by 2016 just on the current stores outstanding (based on 2012A sales). If EBITDA margins hold constant at 19.8%, that would provide $142mm of incremental EBITDA in 2016.
Incremental EBITDA: $142mm
Currently, Chipotle serves breakfast at only 2 locations. On its Q1 earnings call, management acknowledged that they are exploring opening their stores earlier, which could be an early indication that breakfast could be part of the longer-term growth story.
This is a tough one to value as it is so early stage at this point. Let's use some simple assumptions to take a conservative view:
1) Chipotle has 2,000 stores opened by the end of 2016 (conservative assumption)
2) 50% of Chipotle locations can sell breakfast profitably (conservative assumption)
3) Average store earns $2.1mm per year (per 2012 actual results)
Most Chipotle stores open at 11am. Let's say the breakfast stores open a few hours earlier to sell their breakfast products. If we assume these extra hours boost sales by 10%, that gives us 1,000 * $2.1 * 10% = $210mm of incremental sales. At a 27.1% restaurant CM, that provides $57mm of incremental EBITDA.
Incremental EBITDA: $57mm
Chipotle introduced catering in the beginning of 1Q13 in its core Denver market. Test markets were added in April in Philadelphia, Nashville, Las Vegas, and Wisconsin. Management plans to roll out catering nationally this August. Catering is a highly profitable business segment as operations can be streamlined for optimum efficiency. Chipotle's peers have been very successful with catering, with Panera (PNRA) generating 8% of total sales and Qdoba (JACK) generating 7% of sales from catering.
If we assume the catering business ramps up to 5% of sales over the next few years, that would amount to incremental sales of $137mm based on 2012A sales. If we apply the restaurant contribution margin of 27.1% (which should be conservative because margins should be better for catering), this would add $37mm of incremental earnings per year from catering.
Incremental EBITDA: $37mm
Summing up the incremental 2016 EBITDA above, I project Chipotle's 2016 EBITDA to be $1.16billion. See my EBITDA growth bridge below:
By 2016, Chipotle's premium EBITDA multiple should contract closer to its peers as its growth begins to moderate. If the above projections occur, I believe Chipotle will still deserve at least a 16x EBITDA multiple. 16 * $1.16billion = $18.56billion of firm value in 2016, which would represent approximately a 1.68x increase from today's firm value.
Essentially, excluding stock option dilution and cash flow / share buybacks, Chipotle's share price will be $619 by the end of 2016 if the above assumptions are true. I plan to use the above assumptions to watch management's future earnings calls to better tweak my assumptions and evaluate how management is tracking to the longer-term plan. Weakness in any of these areas in the future will of course change my price forecast and potentially my view on the stock.
There is no doubt that Chipotle is trading for a material premium, but this premium is justified by its growth prospects. I am a long-term buyer of Chipotle.
Source: Chipotle 10-Q/K