Shareholders of Chipotle Mexican Grill (CMG) have been richly rewarded since the beginning of 2007, with an average annual compound increase in share price of about 43%. This stock performance handily beats its competitors in the fast-casual restaurant segment. Jack In the Box (JACK), which operates fast casual restaurant chain Qdoba, saw shares decline by about 7.3%, compounded annually. Panera (PNRA) had about 20.4% annual compound growth in share price and Brinker International (EAT), operator of Chili's and Maggiano's Little Italy, had only about 0.6% annual compound growth in share prices since the beginning of 2007. Chipotle has even outperformed its former majority shareholder, fast food giant McDonalds (MCD), which has seen its shares rise by about 21.6% compounded annually since the beginning of 2007.
The consensus earnings per share estimates indicate that more of the same is expected in 2012 and 2013, with growth for Chipotle estimated at more than 28% and almost 25%, respectively. The price to earnings to growth ratio (PEG) reflects that investors have been willing to pay up for this great earnings growth. For 2012, the consensus earnings per share growth estimate is 28.5% and the PEG multiple is 1.73x. The consensus estimated earning growth slows to 24.6% for 2013 and the PEG multiple is 1.61x. These PEG multiples are comfortably below the 2.0x guideline that I follow, so if estimated growth rates are realized, Chipotle will continue to perform through this year and into next.
To make a judgment about the probability that Chipotle will be able to meet its growth estimates, we need to examine recent trends in revenue, margins, earnings, and cash flow. It is also important to assess the company's operating cycle and rate of asset turnover as they give insight into how well the company's leadership is managing its operating and fixed assets. Equally as important to the company's long-term results is the capability and integrity of Chipotle's management. To evaluate management, I will look at how well their interests are aligned with the shareholders' interests, returns on investment they have produced, and the compensation they have taken.
The compound annual growth rate of revenue has slowed from about 25.2% since 2004 to about 20.2% since 2007 and about 19.4% since 2009. However, the compounded annual growth rate picked up to about 22.2% for the past two years. The consensus earnings estimate is contingent upon 21.5% revenue growth, which I believe is reasonable given the historic trends. The company has been able to improve its operating margin to a stable range of 13% to 15% in the past three years from 7.5% in 2006 and 1.3% in 2004. In my opinion, this stability and long-term improvement is very bullish for the predictability of forward earnings. The compound annual growth rate of earnings per share has slowed from about 88.5% since 2004 to about 33.5% since 2007 and about 30.8% since 2010. The consensus earnings estimates call for a further decline in growth to 28.5% in 2012 and 24.6% in 2013, both of which are realistic given that some estimates of the company's saturation point is 3,500 stores. The company currently has 1,230 stores or some 65% below saturation.
Operating cash flow has grown by about 39.5% compounded annually since 2004 and the growth rate has slowed to about 29.3% since 2007 and 25.5% over the past two years. I find it very encouraging that the growth rate in operating cash flow has stayed above the growth rate of revenue and has moved closer to the growth rate of earnings per share. In summary, I give earnings estimates for 2012 and 2013 a very high likelihood of being achieved, so I am bullish on the shares at the PEG ratios below 2.0x for this fast grower.
Chipotle's management has been able to effectively manage its operating and fixed assets while achieving outstanding growth. The operating cycle (accounts receivable days plus inventory days) has improved to an average of 2.77 days since 2009 from 3.32 days since 2004, indicating management's ability to streamline its operations. However, because inventory and accounts receivable are minor components of total assets at about 0.6% and 1.3%, respectively, an analysis of the company's fixed asset and total asset turnover is more meaningful. On these counts, management also performs well. Fixed asset turnover has improved to an average of about 2.8x over the past 3 years from an average of about 2.4x since 2004. Likewise, total asset turnover has improved to an average of about 1.8x over the past 3 years from an average of about 1.7x since 2004. In 2011, these metrics were even better at about 3.2x for fixed asset turnover and about 1.8x for total asset turnover. Management is getting the job done, which is why the shares have been rising so steadily over the past 7 years.
The first measure of the integrity and capability of Chipotle's management is how closely their interests are aligned with mine as a potential shareholder. As a group, the key insiders, which include five executives and five independent directors, hold 525,685 or 1.7% of outstanding shares. This percentage of ownership is higher than both Jack In the Box at 1.4% and Panera Bread at 0.8%, but is down by about 5.3% over the past twelve months. I rate this as a neutral-to-good factor for Chipotle.
The next test of management's integrity and capability is the returns on investment they have produced. Chipotle scores very well as return on invested capital has steadily improved to about 23.2% in 2011 from about 13.1% in 2008 and about 2.7% in 2004. And it is also very bullish that the company has done this without long-term debt. So return on equity has tracked return on invested capital.
Finally, I look at the compensation the company has taken in comparison to revenue growth, returns to shareholders, and compensation taken by direct fast casual dining competitors. Chipotle has increased its compensation to its key executives by an average of about 36.6% compounded annually since 2007. This is very reasonable given that the share price has risen by about 43.0% compounded annually over the same time. There are no dividends to consider, so the return to shareholders is the increased share price. This is very positive for the company, yet when considering revenue growth, the picture appears less pleasing.
As a percentage of revenue, compensation has increased to about 2.2% in 2011 from about 1.3% in 2007. Chipotle's direct fast casual dining competitors have both had lower compensation ratios. Jack In the Box's managers had compensation of 0.5% of revenue in 2011 and 0.2% in 2007 while Panera Bread's managers got compensation of about 0.6% in 2011, up from about 0.2% in 2007. These lower management payouts are deserved in my opinion because their share prices have badly lagged Chipotle's. Jack In the Box has seen its shares decline by about 7.3% on average since 2007 while Panera Bread's shares have risen by about 20.4% compounded annually since 2007. On balance then, I am satisfied that Chipotle's management has its interests in line with shareholder's and that they meet my standards for integrity and capability. In fact, I think the CEO and his team should be paid even more for the good work they've done.
Despite the huge run up in shares that are near an all time high at a recent $432 per share, I believe that Chipotle is still well positioned to reward shareholder's with outstanding growth, profitability, cash flow, and ultimately a much higher share price. Shares are reasonably priced relative to future growth, which I think is realistically attainable, and management has shown that it has the capability and character to continue to boost Chipotle's intrinsic value for shareholder's benefit.