3 Trends Affecting Chipotle Mexican Grill’s $400 Valuation

by Trefis Team
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CMG
Chipotle
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Chipotle Mexican Grill (NYSE:CMG) has had a volatile 2012. The stock went as high as $438 after a strong first quarter. However, its second quarter results failed to live up to investor expectations and the stock plummeted to $280. The stock has recovered more than 20% since. Chipotle was also upgraded to ‘buy’ by ITG Research on September 17 which further buoyed the stock. [1] Amid all the volatility, here are 3 factors that Trefis estimates are crucial to the long-term health of the restaurant chain.

1) Comparable Sales Growth

Chipotle’s comparable sales grew 11.2% in 2011 (y-o-y) out of which 2.9% was contributed by menu price hikes. In the first quarter, Chipotle’s comparable sales growth rocketed to 12.7% helped by menu price increases (which were implemented in Q2 2011) and a rise in customer footfalls. However, the figure decelerated to 8% in the second quarter; something which did not go down well with the investors. [2]

We don’t reckon Chipotle performed badly. In fact, it is still better than the management’s forecast. In its annual report, it is clearly written that the management expects comparable sales growth of mid-single digits since it does not plan to raise menu prices in 2012. Achieving 8% comparable sales growth in the absence of menu price increases is pretty significant, but the market became over-optimistic after its first quarter comp sales figure, focusing only on the headline figure.

Comparable sales growth is an important metric to evaluate the performance of a restaurant since it excludes the restaurants opened in the last one year, the figures of which may be unusually high or low.

We expect the comp sales to gradually decline in the subsequent years since it will become increasingly difficult to sustain such high levels of growth over a larger base. New restaurant additions also impact the sales of existing restaurants negatively. Moreover, competition starts offering similar (and cheaper) offerings which again puts a downward pressure on comp sales. For example, Taco Bell launched a new Cantina Bowl earlier in the year to take on Chipotle. The burrito as well as the Cantina Bowl, both part of the new menu, were priced under $5, compared to $8 at Chipotle.

So, if Chipotle’s comp sales figures were to show a gradual decline in the subsequent quarters, we estimate there is no need to panic; rather it is quite natural over the course of a lifetime of a restaurant chain.

See full analysis for Chipotle Mexican Grill

2) Expansion

Chipotle plans to open 155-165 restaurants in 2012. In the first six months of the year, it added 87 new restaurants so it looks like it is likely to meet its target.

However, in the coming years, the rate of expansion could slow down as its presence in the country beefs up for the simple reason that sales of one restaurant start cannibalizing the sales of others. (Remember Starbucks back in 2008 ? The coffee chain had to shut its outlets within the U.S. to reduce cannibalization). [3] Moreover, Chipotle’s premium pricing over other fast food chains somewhat limits the number of restaurants that it can open in one country.

International expansion remains an attractive proposition for Chipotle. So far, the company has only 4 restaurants in Canada, 3 in the U.K. and opened its first restaurant in France in the second quarter itself. However, with Chipotle still to prove itself in international markets, especially Europe, it remains to be seen if the restaurant chain can have the same level of success it had in the U.S.

3) Margins

Chipotle’s margins have continually benefited from lower fixed costs such as labor and occupancy costs (in terms of percentage of revenues). This is because comparable sales growth has generally outpaced the increase in fixed costs. Variable costs such as the cost of food and packaging (in terms of % of revenues) have been volatile but appear under control.

Overall, the rate of revenue growth has outpaced the rate at which costs have risen, thereby leading to higher margins. One risk is that growth slows down in the coming years and this could pressure margins. However we think there is ample room for growth for Chipotle to support its continued growth. At the same time, the company is taking measures to reduce the volatility in its food costs, and we believe that the company control this within a reasonable range in the medium to long term.

Note that all of Chipotle’s restaurants are company-operated (i.e. none of them are franchised), so all of the restaurant’s sales are reflected in the company’s income statement.

We have a $402 price estimate for Chipotle, which is about 15% above the current market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

Notes:
  1. ITG Research Reiterates Buy on Chipotle Mexican Grill (CMG), September 17, 2012, dailypolitical.com []
  2. CMG 10-k []
  3. Starbucks closing 5 percent of U.S. stores, July 2, 2008, seattletimes.com []
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