Few companies engender more loyalty among customers, or stir as much debate in the investment community as Chipotle (CMG). Chipotle has been one of the strongest performing stocks in our portfolio, and we think that Chipotle will continue to thrive and outperform the market going forward. It has far surpassed the S&P 500 over the past year, and we think this outperformance will continue.
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Chipotle takes a different view of the fast-food market than its former parent, McDonald's (MCD). It does not think that fast food should mean lower quality food, and has strived to create a balance between the quality of the burritos it makes and the quantity. We think this is a great business strategy, and we feel Chipotle is poised for great success, for the following reasons.
- Best-in class sales growth. Wedbush, in assigning a $400 price target to Chipotle, said that one of the main reasons for this valuation was Chipotle's unrivaled growth, which will drive top-line growth of over 20% well past 2012. None of Chipotle's peers can rival the sales growth of this company. Revenue grew over 22% in the most recent quarter, despite a percived risk to the company due to wary consumers.
- Resilience against stock-market weakness: Chipotle is perceived by many to be a luxury brand, in the vein of Tiffany's (TIF) or Coach (COH). Luxury consumers' wealth is often tied to their investment portfolios, and as a result Coach and Tiffany's have dropped due to worries that their customer base will stop buying. Chipotle however, caters to a much younger demographic. A person in their teens, twenties, or even thrities will be much less likely to be aware of what is occuring in their retirmennt accounts than an older person who would most likely adjust spending accordingly. Given that most young people only have 401(k)s, we think it is unlikely that they will stop buying Chipotle burritos. It is interesting to note that Chipotle's stock has held up remarkably well during the last 3 months as the debt crisis and debt ceiling debates ravaged the stock market. Chipotle has fallen by just over 7% compared to the S&P's 15% drop. Considering what usually happens to high-multiple and high-growth stocks during a market slump, we see this strength as encouraging.
- Strong employment growth not needed for continued double-digit sales growth. Chipotle bears often note that weak employment growth will grind Chipotle's growth to a halt. Credit Suisse (CS), however, in assigning a $370 price target to Chipotle, did some research on the links between unemployment and Chipotle's sales growth, and found that the employment picture needed to support continued sales growth is very modest. Flat employment growth still allows Chipotle to grow sales by double-digits, a fact backed up by the data. In this case, Chipotle is similair to Apple (AAPL), whose products sell regardless of macro-economic conditions.
- Price increases are not a major concern, neither is perceived price premium: Chipotle has lagged its peers in the restarunt industry in raising prices since its inception. It has always resisted increasing its prices as long as it could, often lagging on a multi-year basis, thanks to its lack of franchising. Chipotle has increased prices no faster than the industry. The perceived premium in Chipotle's burritos is a tiny one. Qdoba, Chipotle's nearest competitor in the casual Mexican dining sector, prices its burritos, on average 2% lower than Chipotle, according to Credit Suisse data. People who shop at Chipotle tend to be wealthier, on average, because they embrace Chipotle's corporate ethics, which have obvious liberal leanings. Customers who can already afford a Chipotle burrito should have no problem absorbing price increases. On the most recent conference call, management has indicated that customers are not resisting, with CFO Joh Hartung saying that "although it is still early, we're encouraged that we've not seen any evidence of customer resistance from either this recent price increase or the earlier one taken out of the West Coast during the first quarter."
For all its admirable investment qualities, Chipotle has one glaring flaw that may turn some investors away from the company. Chipotle is by no means a value stock, and although we feel that the fundamentals of the stock support its valuation, market sentiment may not. Chipotle has held up well in the recent market rout, but that is not a guarantee that it will continue to do so. In its report, Credit Suisse values the business at $420, but applies a 35% chance of recession, as derived by its economic research team, yielding a final price target of $370.
We think that this is a critical aspect that further serves to highlight the endurance of the Chipotle business model and the appeal of the stock to growth-oriented investors willing to stomach potential volatility. At nearly 40 times forward earnings, Chipotle will have to execute just right to maintain such a valuation. But Chipotle's management bench is very deep, and the company's customer base is loyal, and continues to expand.
Chipotle's London restaurant, its first international location, is doing very well. According to Co-CEO Montgomery Ells the:
London restaurant is doing higher volume than a typical new U.S. restaurant. And that's before adjusting for-on a transaction level, before adjusting for the currency difference. If [you] adjust for the currency difference, its much, much higher than our average restaurant here.
Chipotle is slowly but surely expanding internationally, but in a sustainable way, unlike Starbucks (SBUX) in the torrid growth days of the past. In addition, we will be looking to the next earnings release to hear about ShopHouse, which could very well support Chipotle's growth in an unexpected way.
In times like these, it is important to find stocks that can grow their sales and profits in a sustainable way. Chipotle has proven that it is able to succeed in a sluggish environment and grow the customer base. Chipotle customers are far more loyal than the average restarunt customer, and we think that this fact higlights the cachet of the brand.
Chipotle has had great successes, and we are confident that the future is even brighter. Analysts agree with us. Wedbush just initiated coverage with a $400 price target. Credit Suisse extraordinarily detailed analysis leads it to a $370 price target. Though the Reueters average target is $330.39, we feel that this average will drift upwards as analysts catch up with Chipotle's continued growth.
We think now is a great time to add to, or initiate a position in Chipotle as it begins the next phase of its growth. Chipotle is by no means a value stock, and we do not represent it as such. The truth is that sometimes we, as investors, must pay a premium for industry-leading growth. And Chipotle is that industry-leader.