Back in 2011, Steve Ells, founder and CEO of Chipotle (NYSE:CMG), decided to open a brand new concept to add another revenue stream to Chipotle called ShopHouse Southeast Asian Kitchen in Washington, DC. ShopHouse is a very similar concept to Chipotle in that they stress high quality food or 'food with integrity' as they call it, cooked in front of customers in an open kitchen, and everyone is served as quickly as possible but with a Southeast Asian flavor. Steve has said numerous times that lines at ShopHouse reminded him of the early days of Chipotle when it began two decades ago. So the real question for shareholders is, what kind of value can this add to Chipotle?
They have opened two restaurants, one in DC and one in LA. Chipotle's CFO, John Artung, stated that they plan on opening one more in DC and one in LA this year and four more in 2014. He also stated that they will remain focused on building the Chipotle brand for the next several years before they really start kicking expansion of ShopHouse into high gear which is consistent with their statements in their 10-K. Although I think ShopHouse has the potential to add to significant growth in the longer term, I think it is wise to focus on their core business because they still have plenty of room to grow domestically and they are in the infant stages of their European expansion plans. Nevertheless, I will attempt to look into the crystal ball and model what kind of value ShopHouse can bring to the table in the years to come.
I will analyze the value of ShopHouse using three scenarios: high case, reference case, and low case. There are two main assumptions in each individual case. One is measuring the average revenue per restaurant and the second is the number of restaurant openings for each case. For the reference case, I predicted the ShopHouse expansion plans to start taking off mid to late 2017, for the high case 2016, and for the low case early 2019. Also, for the reference case, I assumed that ShopHouse is not the next Chipotle but very comparable, so I multiplied Chipotle's average revenue per store by 85%. For the high case, I assumed that ShopHouse is similar to Chipotle and multiplied by 100%. For the low case, I multiplied by 70%.
To keep things simple, let's just assume my total revenue and average restaurant sales predictions for Chipotle restaurants are the same for each case. I assume they will be 3% this year given the data so far plus management's expectations of 2013 and 6% growth in average restaurants sales due to the much anticipated price increase in early 2014. I also model for all cases that average revenue for new stores is about a third of stores with one full year of operation based off past observations of Chipotle stores and also that they will open 180 stores for the next ten years. Finally, based on John Artung's comments, I will assume they open two more ShopHouses in 2013 and four in 2014. The rest of the cases will be assumed on an eight year perpetual rate of 4% for each scenario. The data for each case is as follows (revenue numbers are in 1000's):
Reference case predictions:
High case predictions:
Low case predictions:
A few similarities worth noting can be observed from the data. In all three cases, ShopHouse is not relevant to Chipotle's revenue to at the earliest the 2017 to 2018 range. However, in the high and reference case and partly in the low case, ShopHouse becomes an important part of Chipotle's revenue in the turn of the next decade. In fact, in 2022, it accounts for almost one fourth of their revenue in the high case, given my assumptions.
Going back to the nearer term, however, ShopHouse will add little to shareholder value. In fact, I calculated how much intrinsic value ShopHouse adds based off a 5-year free cash flow to equity (FFCE) model (Note: I am not going into detail about my FFCE calculations because the focus on this article is what value ShopHouse adds to Chipotle and not the intrinsic value of the stock). Below I list in each case the value they bring in a per share amount based off my intrinsic value of $401.51 which does not include any value for ShopHouse as of this article's publication.
As you can see, ShopHouse adds little to shareholder value over the shorter to intermediate term horizon.
I believe Steve Ells when he says ShopHouse reminds him of Chipotle at the beginning. I think ShopHouse is an innovative idea whose only current competition may be Noodles & Company (NASDAQ:NDLS) but Chipotle has the opportunity to differentiate itself with its simplistic and customizable menu. However, in the short term, Chipotle will be more focused building the brand of its core business. But when management finally feels the time is right to accelerate the expansion of ShopHouse, I believe it will be a very important part of Chipotle's growth plans.
Disclosure: I am long CMG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.