On January 30, Chipotle (CMG) registered arguably one of the best reports during fourth-quarter earnings season. The burrito maker grew revenue nearly 21% in the quarter, as comparable restaurant sales jumped more than 9% thanks to increased traffic, significantly better than the market's expectations. Though Chipotle had previously announced that its fourth-quarter comp would be better than the 6.2% pace it registered in the third quarter, the performance exceeded expectations by a material margin. We saw similar strength at Starbucks (SBUX) with respect to the composition of its same-store sales growth in the period (mostly traffic expansion), and we think each firm benefited from strategically convenient locations as the industry battled one of the worst winters in the US on record.
The near double-digit same-store expansion for Chipotle in the fourth quarter indicates that the firm is taking share from other fast-casual peers and quick-service (fast food) restaurants, though we note that Taco Bell also continues to do well (the latter has experienced 8 consecutive quarters of same-store sales expansion). It also suggests the market for Mexican food and/or burrito-restaurant concepts is expanding, with consumers flocking to healthier alternatives within this segment. Chipotle's "Food With Integrity" initiatives-"to find the highest quality ingredients [it] can-ingredients that are grown or raised with respect for the environment, animals and people who grow or raise the food"-continues to resonate with consumers.
Chipotle leveraged the strong total sales and existing restaurant sales expansion into a 100 basis point improvement in the firm's restaurant level operating margin, to 25.6%, despite higher avocado costs. Net income during the period surged nearly 30%, while diluted earnings per share expanded at a similar pace, to $2.53. During the quarter, the company opened 56 new restaurants and ended the year with 1,595 restaurants. The pace of existing same-store sales suggests Chipotle has a long runway for future growth in its core concept. Looking ahead to 2014, the company expects to open 180-195 new restaurants and generate low- to mid-single-digit comparable restaurant sales growth during the year, excluding any menu price increases.
Chipotle is truly a fantastic company, and it has taken the fast-casual restaurant industry by storm. Still, its valuation is very lofty, and while we expect the company to continue to meet near-term expectations, any misstep will inevitably send shares tumbling. We're not interested in establishing a position in the restaurant at this time on the basis of valuation. The high end of the fair value range for Chipotle is rough $450 per share, with the company's share price trading well above that presently. Valuation will eventually matter for Chipotle -- shares are always worth the present value of their future free cash flows.
Additional disclosure: BWLD is included in the portfolio of our Best Ideas Newsletter.