Chipotle Mexican Grill: Spicing Up Fast Casual

Feb.25.08 | About: Chipotle Mexican (CMG)

Chipotle Mexican Grill (NYSE:CMG) operates fast-casual fresh Mexican food restaurants in 28 states throughout the US. Its menu includes burritos, burrito bols, tacos, and salads. Customers can choose from 4 types of meats, 2 types of beans, and many different extras, such as guacamole: in total, 65,000 choices available. Founded in 1993 by Steve Ells, Chipotle currently operates 705 units.

We view Chipotle as “best of breed” operator and margin expansion story in the troubled restaurant sector. Shares have taken a beating due to toxic subprime-related headline risk that has tarred the stock even as the fundamental story remains intact. Through a combination of menu prices increases and labor efficiencies, the company is posing phenomenal restaurant level EBIT margins that we think will continue to expand. Given the 5x return in the stock over the last 24 months – and comps deceleration, which is expected of any restaurant looking at unsustainable double digit SSS – a buying opportunity will arise as “first round” investors dump the name, at which point fresh capital should get interested in the longer term 25% EPS growth story CMG is capable of. Net-net, we are midway the 5h inning, there will be some growing pains, but the longer term outlook remains colorful: we’d view pullbacks as rare buying opportunities.  

• The baby boomer generation, time-pressed Gen Ys, and the rise of dual- income families means more people are dining out.

• The fast causal segment remains the fast growing slice of the restaurant sector and its “middle ground” status provides a compelling alternative for both customers and investors looking to park cash among differentiated companies that can survive the stagflation cycle.

• Chipotle is remarkably keeping their ~$900K store opening costs flat in a rising construction environment and capable of modest  1-3% annual price increases.

• Rampant private equity and asset sale activity in the space (WEN, DRI, OSI, APPB) should sustain investor focus on the restaurant industry even as the space comes under pressure from high gasoline prices and the housing market debacle.

• Management has proven to be conservative with guidance, creating room for upside to consensus.

• Viral marketing approach is proving to bears that the Chipotle concept “travels well” – confirmed by our channel checks.

• Well positioned to capitalize on the “Whole Foods effect” and secular drive towards high quality ingredients.

• Greater than expected SSS deceleration will hammer the stock given the metric’s importance among restaurants.

• Soaring commodity costs are Chipotle’s biggest nightmare in the event they cannot defray them through price increases: the ethanol boom has popped corn prices, which have impacted chicken prices to the upside.  

• Rivals are pushing a low cost, “value meal” approach that CMG does not pursue and unlikely will given the management team’s commitment to quality.

• A protracted consumer shakeout would thwart our “P/E re-expansion thesis” and keep the stock range bound.

• Founder Steve Ells is responsible for Chipotle’s brand build-up and rapid growth: if he leaves, so will investors.

CMG possesses $5 cash/share and its $150M in CFO is enough to cover all CAPX needs, which continue to be deployed towards new store openings, which throw off a 40% ROI and remain the company’s best use of cash.

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