Chipotle's Next Concept In Fast Casual Dining Could A Big Winner

| About: Chipotle Mexican (CMG)

Since its initial public offering Chipotle Mexican Grill's (NYSE:CMG) stock has risen over 1300%. This year the stock has gained 44%. The company has over 1,500 outlets in 44 states, with 99% being company owned. It expects to open an additional 150 to 185 new outlets throughout 2013. Outlet are averaging $2.1 million in sales annually, adding to a sales growth of 28% and an earnings increase to 20%. Over the last 5 years Chipotle has experienced sales growth above 20%.

For Chipotle's stock to continue to rise the company must continue to grow. And while there is still plenty of room for expansion of the Chipotle brand both domestically and abroad, the restaurants are becoming more saturated. In order to continue to build, Chipotle is testing a new fast casual concept named ShopHouse Southeast Asian Kitchen. ShopHouse focuses on Southeast Asian inspired dishes such as curries, chicken satay, Laab, and Tofu. The concept is being tested in two locations, Los Angeles and Washington D.C., with a third location to open soon in Santa Monica CA.

What I find interesting about the company's choice of cuisine is that Chipotle appears to be attempting to do the same for Asian food as it did for Mexican food. While there was competition in the Mexican fast food market with such chains as Taco Bell (NYSE:YUM), El Polo Loco, or Baja Fresh, Chipotle opened with a new concept that didn't challenge the other chains, but honed in on one area that was missing in the fast casual market. The company developed a very limited menu featuring high quality oversized burritos priced just a few dollars above its competitors. The company developed a business model that while the cost of its ingredients were higher than the industry average due to a limited menu and a limited food variety there was less waste. Add in a simple decor and food moving to the front chipotle was able to sell a higher quality product at a reduce cost. And the concept took off and proved very successful, as the company adopted the name of a mostly unknown smoked dried jalapeño chili (chipotle) and turned it into a house hold name. Seeing that there was a big market for high quality burritos Jack In the Box (NASDAQ:JACK) entered the fast casual field by opening the chain Qdoba Mexican Grill, Taco Bell developed a better quality burrito, and El Polo Loco began to move from just Mexican style grilled chicken to burritos and tacos.

Chipotle appears to be developing ShopHouse with the same concept in mind as it did for Mexican food. It is not competing head to head against Asian fast casual giants like Panda Express, which has over 1500 location nationwide and revenues of over S1.7 billion in 2012. Instead Chipotle has chosen as Asian concept with little competition - Southeast Asian food. Though growing, Southeast Asian food, which includes Thailand and Vietnam, is still somewhat foreign to the American consumer, and therefore Chipotle can introduce a limited menu of quality and flavorful dishes while not competing with Panda express or even the Ma & Pop Southeast Asian restaurants. And like it did with the smoked chili that bares its name, if Chipotle can slowly introduce the American palate to the flavors Southeast Asia look for ShopHouse to be another successful fast casual destination.

Chipotle is a $13.70 billion market cap company. It does have a very high PE ratio of 44.95. For the second quarter 2013 the company reported $2.82 EPS $0.01. Revenue was $816.80 million beating consensus estimates of $802.80 million, and beating same quarter revenue in the previous year of $2.56 EPS.


Though completely different concepts, Chipotle competes with Panera Bread Co. (NASDAQ:PNRA) for customers in the fast casual segment. Panera, which has 1,652 locations across the US and Canada, has seen its stock drop over 8% year over year after more than tripling its value in the last 5 years. On Oct. 2nd Morgan Stanley downgraded its rating from overweight to equal, citing that 1/3rd of the customers indicated that menu prices were high, leading to perhaps fewer visits. However, Morgan Stanley has a price target of $190 per share, which is well above Panera's Oct. 3rd closing of $156.90 per share. While Panera was being downgraded Morgan Stanley upgraded shares of Chipotle from an equal weight rating to an overweight rating, with a price target of $485 per share.

There is still plenty to like about Panera, and with the dip in the stock price the company looks even better. The company saw a 16% increase in second quarter net income of $51 million, or $1.74 per diluted share compared to $44 million or $1.50 per diluted share in the same quarter 2012. The Company's estimates third quarter fiscal diluted EPS will come in between $1.32 to $1.36, representing an increase of 6% to 10% verses comparable period in fiscal 2012. Panera is still growing; the company expects to open 115 to 125 stores in total by the end of 2013. The company also has no debt. Its PE ratio is almost half of Chipotle's PE ratio with basically the same number of shares outstanding.


Two new fast casual dining chains are also looking for some of the consumer dollars spent at Chipotle. Noodles and Co. (NASDAQ:NDLS) went public on June 28th at $18 per share, and promptly soared to $36.75 on its first day of trading. The stock rose to a high of $51.97, but has worked its way back down to $43 dollars per share. Still up 17% year to date, I like Noodles and Co.'s concept of a relatively limited menu with the main ingredient being mostly inexpensive noodles topped with various flavors taken from around the world, including Thailand, Japan, Italy, and the USA. I also like that they are not stepping into an already crowded field, as there are few if any chains that specialize in basically noodle dishes.

Noodles and Co. is still a small chain with plenty of room to grow. The 330 plus chain saw roughly $300 million in sales in 2012 with $5 million in net profit. Most of the stores are company owned, as only 51 are franchised, though it does plan to open an additional 100 franchise operated stores. The company plans to expand to roughly 2,000 units over the next 15 years. The question is will it go the Chipotle route and operate these new stores, or will it franchise most of these stores and focus on building a strong franchise business.

I am not so sure how the newest offering Potbelly Sandwich Shop (NASDAQ:PBPB), a sandwich chain out of Chicago, will fair in the long run. Though investors seem to be eager to jump in to its IPO, mostly due to the success of previous fast casual dining stocks, I do have my concerns once the hype dies down. Potbelly, a chain of 300 outlets in 18 states, and though high end, it is still a sandwich shop, and therefore the competition will be fierce. Potbelly will find itself competing in a crowded field that has seen numerous sandwich chains shrink in size, like Quizno's.

Potbelly however has a number of things in its favor, its profits at the store level are over 20%, and net profit was over $24 million in 2012. It also has one of the most successful entrepreneurs of our time behind it in Starbucks (NASDAQ:SBUX) CEO Howard Schultz who hold a 28% stake in the company through his venture-capital firm, Maveron.

What I don't like is that the expected $94 million from the IPO is being used to immediately pay out approximately $50 million in already declared cash dividends, along with working capital and general corporate purposes. As an investor I'd much rather see the money spent on opening new outlets to grow the company and its stock instead of giving it to early investors so they could feed at the potbelly trough. It will be interesting to see how much of a move the stock takes after the IPO. This stock, like Noodles and Company may shoot up and then come back down to a more reasonable entry price.


While I believe Panera, Noodles and Co., and even Potbelly have potential to grow and be good investments, I think Chipotle, even with its high PE ratio, is still the best of the fast casual companies. I like that the company is able to find a niche in a segment and convert it into a mainstream product. And even if ShopHouse proves not to be successful, the company hasn't over-invested in the concept, so it should not hurt the brand or the stock. Chipotle appears to have room to grow and should continue to be a long term winner for one's portfolio.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.