Chipotle: Still Room For Earnings Growth
Summary
- Chipotle is one of the largest restaurant businesses operating over 2,888 restaurants and holds an enterprise value of $50 billion.
- With total revenues increasing 7.1% in 2020, I believe Chipotle displayed its iron-clad business model through its positive growth rate in the midst of a pandemic.
- Through its food integrity initiative, focus on digital services, and potential expansion internationally, Chipotle has a solid growth runway in my opinion.
Michael M. Santiago/Getty Images News
Thesis
Chipotle's (NYSE:CMG) future growth runway will be driven by three main catalysts in my opinion. First, I believe domestic growth may be spurred through Chipotle's "Responsibly Raised®" food integrity program where they aim to only serve meats that meet specific sustainability and animal welfare criteria. I also believe continuous domestic growth will be supported by the further adoption of digital and delivery services. Lastly, the potential international expansion opens the door for exceptional future earnings growth in my opinion. As of the end of 2020, international Chipotle restaurants accounted for only 1.5% of total locations, leading me to believe this is a relatively untapped area.
Background
Chipotle Mexican Grill has a simple menu while focusing on serving 'real food' that is responsibly sourced, classically looked, and does not include artificial flavors, colors, or preservatives.
Source: Chipotle
Chipotle was started 25 years ago and today is still devoted to seeking out the best ingredients through its Food With Integrity program. Chipotle's first restaurant was opened in Colorado in 1993 and now operates 2,888 restaurants with 2,846 in the United States and 42 internationally as of 9/30/2021.
Since going public at the beginning of 2006, Chipotle has returned 36x to investors, an annualized growth rate of 27%.
Source: Created By Author Using Data From TradingView
Thesis Support
Food Integrity
One of Chipotle's main focuses is serving high-quality food while maintaining reasonable prices for customers. Chipotle aims to serve meats only in accordance with their established "Food With Integrity" criteria while also aiming to improve sustainability and promote animal welfare. Meats used at Chipotle do not use non-therapeutic antibiotics or added hormones and produce is responsibly grown meaning there are specific environmental considerations taken into account.
According to Sustainable Brands, 69% of Americans care about animal welfare when making food considerations. Along with animal protection support, 77% of Americans say sustainability factors into food-purchasing decisions.
Source: Sustainable Brands
While growth specifically related to the American consumer's consciousness for animal protection and sustainability may be slow, I do believe it will be a long-term loyalty catalyst if Chipotle can continue delivering on its Food With Integrity program.
Digital Services
I believe Chipotle's digital platform is a strategic growth driver for Chipotle. In 2020, Chipotle grew revenues by 7.13% in a year that the cumulative growth rate of the restaurant industry was -15.18%. I believe the main reason Chipotle was able to maintain a positive growth rate during COVID was because of its ability to adapt to a digitally transforming world. In 2020 Chipotle digitized almost every takeout-make line, expanded partnerships with third-party delivery services, and added more Chipoltlanes (the drive-through format for customer pick-up of digital orders).
Digital sales (including delivery and customer pick-up) accounted for 46.2% of sales in 2020 compared to 10.9% in 2019. This was clearly a major benefactor to chipotle over the course of COVID which allowed them to continue growing on the top line. I believe this digital transformation also shows management's competence during this time and provided what I believe was a strong competitive advantage in the industry.
International Expansion
Source: Created By Author Using Data From Chipotle
As of 9/30/2021, Chipotle's international restaurants accounted for less than 1.5% of total locations. Because of Chipotle's excellent U.S. growth spurring annualized revenue growth of 24.38% over the past 10 years, I believe they haven't found a need to focus internationally. While I still believe Chipotle's current growth runway through digitization will provide a solid investment basis, I believe the international opportunity presents an even greater catalyst.
The main risk internationally is cultural preferences. As an example, Taco Bell (YUM) launched restaurants in London and Birmingham in the late 80s and were soon closed in the mid-90s as they were unable to find profitability because of minimal demand.
Chipotle recently opened up eight new restaurants in Canada and is testing new restaurants in the U.K. and France this year as well. Chipotle's CEO Brian Niccol explained that they are testing in European markets with new restaurant layouts and ingredients before denoting significant CAPEX for further expansion. I believe the real growth internationally may still be years out but proper planning and potential execution by management may allow for this segment to provide a long-term growth runway for Chipotle.
Financials
Model Highlights
Source: Created By Author Using Data From CMG 10-K
Valuation
Over the past 15 years, Chipotle has traded in what I believe is elevated, slightly upward sloping next twelve month [NTM] P/E channel:
Source: Koyfin
Purely based on the historical trend, I believe Chipotle trades slightly over the median NTM P/E (shown as the dotted line).
Historically and currently, Chipotle trades at a large premium to competitors in my opinion:
Source: Koyfin
Comparing historical results from competitors to Chipotle on a P/E basis, I found Chipotle typically trades 28.5x above the competitor average:
Source: Created By Author Using Data From Koyfin
I also found Chipotle's competitor-implied P/E, adjusted for EPS growth, using Wall Street analyst estimates for FY 2023:
Source: Created By Author Using Data From Koyfin
Price Targets
Source: Created By Author Using Data From Koyfin
Risks
I believe a lot of Chipotle's risk is valuation and competition-based. The reason for Chipotle's premium multiple relative to the competition is mostly due to their superior growth rates and margin expansion potential in my opinion. The street is currently forecasting GAAP EPS of $41.27 in FY '23, 3.3x larger than EPS reported in 2020 (a year where earnings grew as well). While I think this is feasible for Chipotle, the potential for competition to mitigate growth is also a large possibility.
I also believe if Chipotle is not successful in integrating internationally over the next 2-5 years and the project turns out to be a CAPEX burn, margins could potentially retract and you could see earning growth stunted significantly. If that happens, multiples could contract leading to potentially strong drawdowns in stock price.
Summary
Chipotle is a restaurant I've enjoyed for a very long time. I think the food tastes great, the menu is simple, the ordering process (both digitally and in-person) are highly efficient, and it's a very reasonable cost. I believe many others feel similar about Chipotle as their last recorded net promoter score was 69, well above much of the food industry according to customer guru. Alongside customer loyalty, I believe management is also guiding Chipotle in the right direction. I think their digitalization response during COVID was a reflection of this and their focus on easing into international markets will be positively reflected in earnings in the long run.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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