Chipotle Mexican Grill (CMG) has been growing steadily after its humble beginning in Denver, CO, in the 1990s, its successful initial public offering in January of 2006, and since October of 2006 when its early investor McDonald's (MCD) sold its stake in Chipotle for $1.5 billion after investing $360 million over a seven-year period. Currently, Chipotle has 31.3 million shares outstanding, a market capitalization of $12.9 billion and an enterprise value of $12.4 billion (the company had no debt and $400 million in cash as of December 31, 2011) and operates directly about 1,300 restaurants primarily in the U.S. While the stock is expensive, I believe that it is a good long-term investment with a scalable business model that the company successfully continues to expand in the U.S. and abroad. Chipotle is focused on quality rather than price and is able to attract customers from both fast food as well as casual dining restaurants. In addition, Chipotle is finally starting to expand its menu (including breakfast and kids menu), which will further contribute to average store sales and profitability. While Chipotle had problems in 2011 with the Federal government for employing illegal immigrants it bounced back quickly, proving its resilience.
Chipotle is trading at a price-to-earnings (PE) ratio of 61 compared with a price-to-earnings ratio of 22 and 15 for the industry and the S&P 500 (SPY), respectively. Some of its notable competitors have also cheaper shares as measured by the PE ratio with Yum! Brands (YUM) at 25, McDonald's at 19, Panera Bread (PNRA) at 36, and even the ever growing Starbucks (SBUX) PE ratio at 32. What makes Chipotle selling at a premium is that it has a higher growth rate than the rest of its competitors. For example, Chipotle was able to grow its sales at about 22.5% per year for the past five years while Yum! Brands, McDonald's, Panera, and Starbucks five-year sales growth rate was 11.3%, 5.3%, 17.1%, and 8.5%, respectively.
From a profitability standpoint, Chipotle is not a leader, but it has never tried to sell cheap food at low prices. In fact, all of its pork and chicken and some of its beef is raised naturally. While most fast food companies try to find ways to offer food made of less expensive ingredients to the detriment of quality, Chipotle is mostly focused on sustainable food and even its marketing slogan is food with integrity. This commitment to quality has earned the company a spot on the 50 most innovative companies list for 2012 compiled by Fast Company Magazine as well as other awards and recognitions.
Looking into 2012, the success of Chipotle should continue at the same pace if not speed up. Assuming its net income per restaurant grows at slightly lower rate of 6% in 2012 compared with 2011 growth of 6.3% and factoring in the numbers of new restaurants (about 160) it plans to open, it is reasonable to expect Chipotle to earn $8.33 per share in 2012, including the share repurchase authorized for 2012 in the amount of $100 million. This earnings estimate could be revised upward as it does not include the opening of more ShopHouse (Thai and Vietnamese food themed) restaurants and the increase of profitability due to new menu items such as kids and breakfast menus and possibly a desert offering. Thus, I estimate its forward looking PE ratio at 49 for 2012 and assuming similar growth rate for 2013 a more down-to-earth PE ratio of 42 for 2013. Again, these estimates are conservative and any significant improvement in profits and/or sales from prior trends would make its stock go up or PE ratio decrease.
The competition in the fast-food industry and casual dining industry is fierce. Most participants spend heavily on advertisement and marketing of new menu items that cost less to make and have higher profit margins to finance their promotion. However, Chipotle differs by paying special attention to the ingredients it uses and reinventing the fast-food and casual dining advertisement. Chipotle strives to offer natural and organic food as much as possible and, for example, the company selects farm animal cooperatives that meet certain standards for naturally raising the animals. Also, Chipotle tries to use as much as possible organic and locally grown veggies and its restaurants are known for never using can openers, freezers and microwaves.
In terms of advertisement, the company promotes sustainable farming and is using new media such as YouTube and the country singer Willie Nelson to perform for a nominal fee in an ad emphasizing the natural farming the chain uses. The company spent $32 million in marketing and advertisement or 1.5% of its revenue in 2011. It is difficult to compare marketing, advertising and promotional costs due to differences in financial disclosures but a rough estimate is that Yum! Brands, McDonald's, Panera Bread, and Starbucks spent the following portions of their revenue on advertising in 2011: 5.4%, 3.2%, 1.8%, and 1%, respectively. Only Starbucks spent less than Chipotle in percentage terms. With a Starbucks at almost every other block in NYC, it is difficult to miss it.
In my opinion, Chipotle is competing successfully with the fast-food restaurants by offering a $6 lunch or dinner and also with the casual dining establishments such as Panera Bread and Starbucks by offering healthier alternatives, alcoholic beverages and a clean and cozy place for people to sit and enjoy their spicy food inspired south of the border. All this gives Chipotle an advantage over its competitors as the company can take on more risk due to its unmatched offering with a minimal increase in its promotional costs. If unsuccessful, it could always go back to basics. For example, Chipotle can start offering a desert as it needs a desert item. Also, currently, Chipotle does not offer catering/delivery, which is another area of growth. Assuming a desert items and catering improves profitability by $3 per share ($2 and $1, respectively), Chipotle's PE ratio is actually 36 for 2012 instead of 49 as I estimated earlier. With a stable customer base and growing popularity, Chipotle will be able to continue rewarding its shareholders one way or another in the coming years.
Customers are increasingly expecting healthier food even from fast-food establishments. I think Chipotle not only provides this but has even taken extra steps by focusing on how its basic ingredients are raised or grown. As mentioned earlier, Chipotle Mexican Grill stock is expensive. However, I believe the high price is warranted in this case and it is still not too late to take a profitable ride on the Chipotle train (hopefully without eating a bean burrito beforehand). The base for an excellent national and soon global fast-food chain is set. With its proven management team, Chipotle should be able to continue to execute well and build its brand. So far, I trust Chipotle can cater to the appetites of its customers for more natural ingredients and to that of its investors for growing profits while promoting sustainable farming.