Chipotle Mexican Grill (NYSE:CMG)
Presentation at William Blair Growth Stock Conference
June 11, 2014, 11:00 a.m. ET
Steve Ells - Chairman and CEO
John Hartung - CFO
…in London, Paris, and Frankfurt, while also pioneering new concepts in the U.S., including ShopHouse Southeast Asian Kitchen and Pizzeria Locale. So I’m required to inform you that we have a full list of research disclosures of potential conflicts of interest at williamblair.com, and they are not going to do a formal presentation. Instead, they’ve agreed to be interrogated by me, so we’re going to do a fireside chat, without the fire, unfortunately.
So you’re closing in on 1,700 locations in the U.S., and trends have probably never been stronger. At Chipotle, you’ve had double digit comp gains, all-time high throughput, and improving unit volumes. So that’s my advertisement for Chipotle.
How do you envision the ultimate number of potential Chipotles in the U.S., and how has the A Model format impacted returns, or that ultimate potential?
Well, in terms of ultimate potential, I think there are two key drivers to creating that ultimate potential. And really, rather than try to figure out what the number is, it’s more important to figure out what makes the number bigger.
And really, what makes the number bigger is having a food culture that is relevant to consumers, something that they can really identify with and have part of their everyday life. And so our insistence on finding better and better ingredients through food with integrity, and making the kinds of ingredients that were once available only at high-end grocery stores or high-end restaurants available to everybody is something that’s really, really appealing.
Not only is it contributing to better tasting food, but also, people are much more curious about the impacts of our food system on the environment and their health, and animal welfare. And so we’re addressing these issues head-on, and really being a leader in this, and that creates a really great trust. More and more customers are coming to Chipotle because of that, and our existing customers come more often as they understand the message.
The second part to creating more opportunity for the brand is by having a people culture that’s truly unique. And I think our people culture in the restaurant business, especially the fast food business, is truly unique. It’s one that empowers top performers to achieve really high standards. It’s a system that promotes folks from crew level all the way up into leadership positions.
And we have a system called the Restaurateur program that enables that. So every crew member comes in and knows that he or she has this opportunity. In fact, we want them to become the future leaders of the company. The sexy positions are not for folks who come from the outside with lots of experience, necessarily, but from those who have demonstrated that they can make those around the better and delight in serving each and every customer, and really appreciate what it takes to prepare delicious food.
So these are two very, very unique things within the world of fast food, and customers are noticing this. And I would argue that maybe this Chipotle format, the system, is the new fast food. And so we’re creating more and more opportunity for this eventual number that you speak of.
You asked about A Model, as well as Sharon, and how did that add. You know, A Model has been a great addition to our development strategy. We came up with A Model during the recession, where it was tougher to find real estate, where we needed to go into a lot of existing sites.
And so it was very opportunistic. We think it added incrementally during that time, so that we could offset the fact that a lot of new developments weren’t coming out of the ground. And so it took an opportunity away from us. We were able to replace that with A Model.
But what A Model taught us is that there’s a lot of [traders] that we can go into that we were hesitant to go into before, where the demographics weren’t as strong, where we were concerned that our economic model wouldn’t be as strong, and so we found a way with A Model to offer the exact same experience with a lower investment, lower operating costs.
And so we think it added to our opportunity, and so when we talk about this calculation of up to 4,000 restaurants, which is kind of the same potential we’ve been talking about since 2006 when we went public. A Model added to that. And so we didn’t go back and redo the math, but A Model certainly told us that we can go into a lot of areas and expect extraordinary returns, even at or above the returns that we’re getting with our traditional restaurant.
But it’s also encouraged us to move into other opportunities as well. So we’re in a couple of airports. We’ve moved into malls. And what we’ve found is that as we’ve expanded where we can offer Chipotle, we are doing well in every one of those areas.
It’s a bit of a challenge sometimes to find, to design the right space. Malls, for example. We don’t have the ability to bring our trade [unintelligible]. We have to really jam our kitchen into a small space and so we find that it’s not as efficient. We could do a better job of laying it out, so it’s more efficient for our crew.
But in terms of the customer demand and our ability to provide a terrific dining experience, we’re finding that there are more and more opportunities to do that, in places that we really hadn’t thought about much several years ago.
So on the supply chain, you were really at the vanguard, as you mentioned, of the kind of whole farm to table movement, and bringing that certainly into fast casual or quick service. It’s kind of, I think, difficult for us on the outside to understand the work you’ve put into the supply chain, and potentially how difficult that might be for competition to emulate, either in terms of your pricing structure, your food cost structure, or in terms of actually just sourcing the ingredients. So if you could touch on that.
Yeah, on the sourcing side, I guess I would want to start with a little bit of the history about food with integrity. When I started Chipotle, it was about fresh food prepared in front of the customer, and served in an interactive format. And it still is that today.
But along the way, we became really curious about where this fresh food comes from, and so we started to visit farms. Our first foray into food with integrity, actually sourcing a raw ingredient that was much different from the typical commodity ingredient, was pork. And so I visited Niman Ranch, a collection of co-ops, under the Niman Ranch brand, in Iowa and some of the contiguous states, maybe a dozen or 13 years ago or something.
And we really, really liked the quality of the pork. It made for delicious carnitas, and there was a great story about the animal welfare and the preservation of the independent family farmer and respect for the environment and so on and so forth.
But there wasn’t nearly enough of this great pork at the time. I think we had perhaps 60 restaurants, and there might have been 45 or 50 of these farms in the organization. And they weren’t big enough to supply us completely. But we worked with them over a year or year and a half period, and they built up their business faster than we actually grew our business. It turned out there was a one to one relationship, one independent family farm could supply one Chipotle.
We’ve been working with them ever since. Today, they have over 550 farmers in that co-op. Of course, we have many, many more restaurants, and we’ve gone beyond Niman Ranch now to supply our pork, with other suppliers, who have adopted the similar protocols. Raised outdoors, no antibiotics, no growth hormones, this sort of thing.
This is the story with most of our suppliers. We get to know them, understand their protocols, and work with them to help grow the business. But as our growth has necessitated more and more supply, we’ve also turned to larger suppliers and asked them to perhaps change their existing commodity protocols in favor of something more in line with food with integrity.
And so really, you have to come at it from all different angles. You have to find new small suppliers who are willing to grow. You have to find people who are already doing a great job and just assemble lots of disparate small suppliers into organizations, and you have to attack the problems at larger suppliers and see if they are willing to change their protocols. And often, many of them are.
So we’ve been able to keep up with demand. Mostly. You’ll notice now and again we’ll have a blackout of a certain meat, chicken, for example, might not be as available during certain times of the year or certain problems happen. But for the most part, we are keeping up with the growth of the company.
In terms of our model compared to others, first of all, we welcome other restaurant companies and other grocers to source the same kind of ingredients. We think that’s better for the environment. We think it’s better for animal welfare. We think it’s better for the health of customers. And we think it’s better for the supply chain as well, and we think the more demand grows, and the more supply grows, that’s going to be better for Chipotle as well.
The supply that we’re getting today didn’t exist 10 years ago. We didn’t have enough hogs to supply a restaurant company which was very small at the time, let alone chicken, steak, some of the organics that we’re buying, or the local produce that we’re buying.
And so we’ve really worked with our suppliers to build up the availability of this food over time, and we would love it if other restaurant companies would try to source some of the same ingredients. We think that’s a win across the board for everybody.
But it’s hard for others to do this within their model, and the reason is because we’ve been building our business model from the beginning to allow us to invest in higher quality food to do so without charging higher prices to our customers. Our prices today, even though we’re increasing prices in a number of markets, kind of as we speak, our prices even after increasing our prices is still at or below most of our competitors.
And so it’s hard for somebody else to say, okay, we’re going to start sourcing higher quality, more expensive food because something has to give. Either you have to charge higher prices, or you have to accept lower margins. We’re able to do this, where we can buy as much of the higher quality food as we can, and pay that premium. We can charge a fair price or a lower price than others, and yet have the highest margin returns in the industry. That’s really hard to replicate.
Now, the way you do that is one, you stay very focused, which we have. We’ve stayed focused on a focused menu and our innovation has been improving the quality of food and the way we prepare our foods, so the food’s always more delicious, without throwing a lot of new menu items at the menu.
And then two, we have a wonderful people culture, and it’s amazing, when you put great people together, and you create encouraging circumstances, such that they all feel like owners in the restaurant, it’s amazing how they can produce a better customer experience, they can cook and serve better tasting food, and you can get better business results as well. And so that’s what makes Chipotle special, and why we welcome others to go out… To source the kind of food that we’re sourcing, from an economic model standpoint, it would be hard for them to do so.
So throughput has clearly been jaw-droppingly good the last few quarters. You’ve had all-time high throughput despite what we know was a pretty bad winter here in the U.S. So just curious if you could talk about what really changed in the throughput equation for you over the past few quarters. And then secondarily, I think you have your highest throughput location here in Chicago. Jack always tells me if I don’t like throughput there, I’m not going to like it anywhere. So could you talk about how much you can do per hour on Franklin versus the company average at this point?
You know, throughput, we have not changed our focus on throughput. We’ve not changed or come up with any new gimmicks or technology in terms of how to improve throughput. We’ve been talking, for those who have followed us for a while, we talk about the four pillars of throughput.
And it’s the same four pillars. We need an expediter, a linebacker, aces in their places, and mise en place. And I won’t go through all four right now. Anyone who’s followed us for a while, you know what those four are. What we’ve done in the last year, what we’ve done a much better job of, is being aware of where we’re doing it well, and where we’re not.
Of course, in 230 West Monroe, which is one of the fastest, there is kind of a competition between who’s faster, between Chicago restaurants and New York restaurants. And so the restaurant that Sharon’s talking about does well over 300 on a regular basis. And they do it in a way that looks effortless.
When you go into the restaurant, you’re saying, well, this just looks average. They must be doing 120, 150, or 160 or so. Until you count the people, and you realize, oh my god, they are on a pace to exceed 300. And it’s because they’re fully staffed, they have the four pillars in place, and so they don’t have people leaving the line.
And the movement that you’re seeing in a line like at 230 West Monroe, where we’re serving more than 300 customers per hour, is more at the customer level. You see this constant, steady movement of the customers, where the crews stay where they’re at, and they’re facing the customer and they’re serving the customer, and it’s because mise en place means everything’s ready, all the food is ready, they’re not turning around to change pans. If they do run out of a pan on the line, we have the linebacker that will change that for them.
So the person that’s serving you, every single person along the line that’s serving you, they don’t need to do anything other than look you in the eye, communicate with you, and serve you. That’s how we’re able to deliver so much, such fast throughput.
The biggest difference between the throughput we’re delivering today and the average restaurant, there are two differences. The average restaurant does somewhere between 110 and 120. You know, one is Monroe has unlimited customers. At 12 o’clock, everyone comes out of their office buildings and they show up. And so you kind of have an unlimited line. Not every restaurant has that.
But two, they have a wonderful crew of people, and they have a wonderful people culture. So the single biggest thing that we can do is make sure that we advance our people culture, as Steve mentioned. And if we continue to hire top performers, continue to create encouraging circumstances, such that everybody in the restaurant feels empowered, and they feel like they own the restaurant, our throughput will continue to get better and better.
And one last thing in terms of awareness. It sounds simple, but we use our security system to identify how well we’re doing, and report it back to our field teams. And the field teams have said, yeah, listen, we’re doing four pillars. Really? Every restaurant? Every one of them. Boy, I was in the restaurant yesterday, and you’re not doing it. Well, that one we were down a guy, a person, that day, but everywhere else we’re doing it.
Well, when you can look at our security system, and see every one of the restaurants, and you can see that in some cases restaurants, field leaders, have said, I’m doing four pillars in 100% of my restaurants, their rates were more like 40% or 50%. And it was eye-opening. And when I say 40% to 50%, we would have a linebacker maybe in 50% of the restaurants. We’d have expo in maybe 60% of the restaurants.
We have moved all of those execution figures from 40% to 60% up to 70% to 90%. That’s the single biggest change from last year to this year. Not a change in how we do it. It’s not a change in the focus of our people, but it’s more awareness that you think you’re doing four pillars, but you’re not, and that awareness has really generated significant change in our throughput.
You haven’t raised prices yet in Chicago, I don’t think, but you’ve been raising them elsewhere. And I’m sure Chicago’s on the come. So can you talk about your thoughts on pricing, because you’ve traditionally, historically, not touched the menu that often relative to your peers. I’m curious as to why that would be the case. And then when you take price, you take more than average. And how you think about the sustainability or the defendability of your restaurant margins.
We’re in the process is increasing our prices in all of our markets. This is the first national price increase we’ve taken in three years. Sharon’s right that we generally have been a lot more patient to take an increase in prices than certainly most of the people in this room would like. When we see inflation, when we see the cost of our ingredients increase, we know we’ve got high margins, so we don’t have to be in a hurry to rush out and raise prices. And we don’t have franchisees either.
Those two things, when you have low margins, and perhaps you have debt payments, you have cash flow squeeze, you may not have the luxury of being patient and basically absorb food inflation when it comes. We have that luxury. We have that luxury with high margins and we don’t have franchisees, who have debt payments of their own, who are struggling, when higher ingredient costs creep in and they affect their business model.
And so we don’t have the pressures that other companies have that would cause you to be in a hurry to raise prices. We’ve always been a company that does not manage our business based on quarterly results or quarterly expectations. We’ve always managed it for the long term. We’ll continue to manage it for the long term.
And so just none of the pressures that might affect somebody to cause them to say, let’s hurry up and raise price, let’s hurry up and cover the cost of our high ingredients. We don’t feel it at Chipotle, and hopefully we will never feel it.
So what we prefer to do is focus on how do you build the permission to raise prices? How do you create an extraordinary experience for our customers, such that when we have to raise prices, their reaction is well, gee, we knew it would happen sometime, we love Chipotle, and we’re not going to change our habits at all? And we think that would be a wonderful result.
So we spend most of our time creating a wonderful experience, sourcing the very best food that we can, making sure that we prepare and serve great tasting food to each and every customer. And in doing so, when we raise prices, it goes well, which I will tell you, so far, it’s going well. Our expectation was there would be little or no resistance, and so far, even though it’s early, we’re seeing little or no resistance.
Chicago, we’ve not raised prices yet. That will be later this month. We’re up to a little over 1,000 restaurants now that we’ve raised prices, and we do this market by market. Chicago, I think, is slated for the very end of the month, and we expect we’ll be done either by the end of June or early in July.
But this patience about, you know, why don’t you hurry up and do it? One last comment about that. Raising prices is the easiest thing in the world to do. It just takes no time whatsoever. We’ve always felt like having more information in terms of what is food inflation, what are the trends with our beef, what are the trends with our dairy, what are the transaction trends with our customers, what have other restaurant companies done?
We’d rather have more information rather than less. When we do end up raising prices, it is a little higher than average, but we end up bringing our prices about up to or maybe not quite up to what competitors are charging. And so our customers still find that we’re a terrific value, even after we raise prices.
You, not surprisingly, took disproportionate price on beef. Just curious as to whether you’re trying to incent a mix shift there or cover penny profit, or both.
Yeah, it’s a great question. The increase in our steak and barbacoa is quite a bit higher than the increase in our chicken, and in essence, we want to pass on the higher cost of beef. That’s the single biggest item that has increased in prices over the last several months. Our beef prices in April were 25% higher than they were in the fourth quarter of last year.
One advantage in terms of waiting a little bit longer was we were able to adjust our pricing on steak and barbacoa at the very last minute. Literally, the week before we were about to raise prices, we had seen our beef prices increase pretty dramatically, and so we made a last minute change.
And the change ended up widening the gap between chicken and steak, which before the price increases, was about $0.35 or so. So if you came in and instead of getting chicken, you decided to get steak, you’d pay a $0.35 upcharge. We increased that to about $0.70 to $0.80.
The reason for that is we didn’t necessarily want to incent people to shift, but we wanted to put this choice in our customer’s hands. Steak costs more today, and so we wanted customers to choose whether they wanted to pay $0.70 or $0.80 more to pay for the higher going rate for steak.
If they choose to continue to buy steak, we end up earning a higher margin, a higher penny profit on chicken. And so if they shift, which we kind of expect some will shift, it’s a win for us. It’s a win from the customer standpoint too, because our customers - and a lot of you guys probably are in the same boat - you don’t change your order very often. And you come in and you get steak every single time, or chicken every single time.
And so if a customer comes in and says boy, it’s a little more expensive, I might try the chicken, you know, we think that’s wonderful for our customers to search around the menu a little bit and try different things. Very often, when somebody says they come to Chipotle and get the same thing every day for two years, and then they switch, they find a new thing that they love, and then they’re stuck on that for two years or so. So we think if we nudge them a little bit, that’s just fine.
So I want to maybe shift gears and talk a little bit about international, maybe focusing a little bit more on Europe than Canada. You know, how you’re seeing the European locations do, if you want to maybe contrast Paris and Frankfurt versus the original sites in London, what you’re learning. And handicap maybe the success of Mexican overseas. I’m not sure that we know yet if people only like Mexican in North and South America, but if you can give us some perspective on that.
Well, I think that overall, we’re doing very, very well in Europe, and I’m really proud of the teams there. It’s interesting, we started in London, with our first store, well over three years ago now. And initially, it was a lot of expats. But as time has gone on, and as we’ve opened more restaurants, we have six there now, it’s locals.
And it looks very much the same as our new restaurants did in new markets in the United States. The restaurants are comping very well now. We started out with relatively low volumes, though, compared to what we see in the United States. But we also saw that in some of our new markets in the United States, such as California, which quite honestly, started out very, very low. We even considered stopping expansion in California, not understanding why we didn’t have great volumes. California today is one of our best markets, though, saleswise.
So we’re really excited about the potential. The teams there are excellent. Both Paris and London started with a restaurateur from the United States. They hired their original team and from that original team, all the managers for the subsequent restaurants have come from that store. Additionally, restaurant manager for Frankfurt came from one of the London stores.
So it’s really great to see that the people culture is thriving there, and that’s providing really, really great customer service, in addition to great food. I see people when I’m over there really enjoying Chipotle. Again, it’s a new service format. They’re new flavors. It’s a new way of thinking about something quick to eat. But people are really, really taking to it, and I think the strongest indicator that we’re on the right track is that we’re seeing good comps.
So just segueing into different flavor formats, ShopHouse, it seems as if the locations in California might have been off to an, in an aggregate, faster start than Washington, DC. You can contradict that or correct that if you’d like. Just curious, on ShopHouse, how you feel the progression is going there.
I suspect with ShopHouse that the fact that you don’t have avocados in the menu is probably a positive and a negative, because avocados are expensive, but half of people get guacamole at Chipotle, so you probably have a higher average check at Chipotle than ShopHouse. Just some thoughts around ShopHouse, where it is, what you think the margin structure could look like.
I’ll just talk about the margin structure. The economic model for both Pizzeria Locale and ShopHouse was built to be the same as Chipotle. So the potential for the economic models are the same. The one variable, though, is the sales. These are two new brands that are just starting, so obviously you don’t have the same kinds of sales that Chipotle has.
Chipotle now, when a new restaurant opens, they open up very, very strong, and that continues to be stronger and stronger. It’s a national brand. It’s a recognized brand. But they are operating like really good new markets operated for Chipotle in the early days.
I think they’re really both very exciting concepts, and they’re both based on the Chipotle format. So what I think the huge potential is here is to leverage our field structures so that the field managers can run all three different brands. And they’re doing that now in Los Angeles and in Washington, DC.
And so when one of these field managers comes into a ShopHouse, they really see a very similar thing that they would see at Chipotle, even though the cuisine is different, even though from a customer perspective, it might look very, very different. From field management team, it looks the same. So we have an amazing opportunity to leverage this infrastructure that we’ve built up over the years.
But I think the most important thing to look at is the potential to introduce a way of eating that’s very, very different from typical Asian food, and typical pizza in the United States. And both of these brands are wildly different than the typical offerings, just as Chipotle was wildly different from the typical fast Mexican offerings.
And so to me, that’s the real potential, to change the way people think about and eat fast food, through something that not only is very, very appealing, but different in a really good way.
One last question on marketing. It seems like you’ve really cracked the code on marketing, perhaps, over the last 18 months. Can you talk a little bit about the shift in marketing, and the messaging? How many of your customers do you think really now understand the ingredient quality that you have versus maybe just implicitly understood it before by the taste? And if you could talk about brand awareness. I mean, obviously, your new unit volumes have been tremendous. Is the marketing playing into just overall increased brand awareness throughout the country?
I think so. But I would say that our marketing really hasn’t kicked in in the last 18 months. So we think about marketing, and we have sort of three different buckets for our marketing program. One is what we call our cultivate a better world marketing, things like back to the start video, the cultivate festivals, farmed and dangerous TV series. Those things are the cultivate a better world marketing, where it’s a difficult message to try to get people to understand why it’s important to understand where your food comes from.
And it has been very difficult for us in the past to convey that message, and we think that particular cultivate a better world bucket is doing an amazing job delivering that message, and we see people understanding it more, and it becomes important to them also, as more and more people are discovering this.
The second bucket is our local store marketing program. But this is something that we’ve been doing for 21 years, and this to me is probably the most important marketing component that we’ve had. Before we had a marketing budget, before we had sophisticated marketing programs, we developed relationships with customers from the store level to the local community, face to face.
And really, it is the best way to develop a strong relationship with customers. And they in turn bring their friends and families in, and it builds that way. We’ve continued to refine that local store marketing program and just recently reorganized a little bit. We have 26 dedicated local store marketing specialists throughout the country that work directly with the field teams and directly with the managers in the restaurants.
And it’s never been stronger. And in fact, some of our comp is attributable to the fundraisers that develop through that program. And we have specialized custom currency that we can track, to watch how these fundraisers have brought in new customers and increased the rate of existing customers.
The third part is our top of mind awareness, things like billboards, media, TV, radio, things like this. And it’s more traditional in its approach, and it’s just the top of mind awareness. You’ve seen the billboards. It’s, you know, pictures of food, talking about our food, skillfully made, letting people know that we’re cooking in the restaurants.
Together, though, you look at this marketing program, and we think this is, again, bringing more and more awareness of what makes Chipotle special, and people are understanding that. I think that’s responsible for a lot of the growth that we see.
We’re out of time.
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