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WIKI ANALYSIS
Chipotle Mexican Grill (CMG) is a quick-service Mexican-inspired restaurant chain based out of Denver, Colorado. The company is primarily known for its large burritos, which are served wrapped in aluminum foil. The company emphasizes its simplified menu in which a small set of quality ingredients are combined to create items such as tacos, fajitas, and "burrito bowls" in addition to its burritos. All food items are assembled in front of the customer using an assembly line process.
The company is known for its simple and humorous print ads, its primary method of advertising. Its self-professed emphasis on quality ingredients has led to initiatives such as increasing the use of naturally-raised meats.
Chipotle's stores are typified by an industrial-styled interior with heavy use of dark red color and corrugated metal accents.
Company Overview
In 2007, it opened 125 new stores, 90% of which were in existing markets, allowing Chipotle to benefit from existing customer knowledge and loyalty while at the same time needing fewer promotional resources to drive the top line. In 2008, the company will see 130-140 new stores, per management guidance.
Chipotle has been able to keep its ~$900K store opening cost flat in a construction cost inflationary environment by focusing on less freestanding units and harnessing the economics of smaller stores. Chipotle is capable of modest 1-3% annual price increases (a 1.5% increase on a standard chicken burrito with basic toppings excluding guacamole translates to roughly an 11c increase using our local Chipotle’s $6.04 price point) to offset food inflation.
Trends and Forces
Increasing Hispanic Culinary Influence
Nouveau Mexican Fast food restaurants like Chipotle and Qdoba are catering to the Hispanic market to drive sales. According to the US Census Bureau, 14% of the US population is of Hispanic descent. Hispanics account for over $600B in purchasing power in the US alone and by 2050, 1 out of every 4 Americans will hail from a Spanish-speaking country or region. It is no surprise, then, that the burrito has become an American culinary staple and that the industry is adding Southwestern cuisine to its menu offerings. Chipotle – with its flavorful Mexican cuisine – is positioned to extract value out of this powerful demographic over the next 10 years.
No Time, More Money
The baby boomer generation, time-pressed Gen Ys, and the rise of dual- income families means more people are dining out. According to the US Department of Agriculture, consumption of food away from home accounted for 48.5% of total food expenditures in 2005, from 41.3% of total food expenditures in 1985 and 26% in 1960 -- the NRA is expecting ~53% of every food dollar to be spent on food away from home by 2010. There are 77M Boomers in the US currently and they are getting older and wealthier. According to the US Department of Commerce, US disposable personal income per capita increased at a 1.2% CAGR between 2000 and 2006. Americans can more readily afford to eat out, but they are also more time constrained than ever: according to the Department of Labor, more than 50% of American families were dual earner households and US disposable personal income should grow in the mid single digits throughout the rest of the decade. With both parents holding full-time jobs, less time is left to prepare meals. Simply stated, eating out is the most convenient solution and the industry can quickly ramp capacity to meet demand.
More room for growth
Presently, the company operates all of its restaurants within the US and believes the potential for domestic stores is around 3,000 locations. Since current restaurants only comprise a quarter of that level, there is significant room for growth before the company hits saturation. While domestic growth is still the primary focus, the company will open its first non US store in Toronto, Canada next year. This will likely give management a chance to test out its ability to manage currency risk and international regulatory issues which could be beneficial if international growth becomes a realistic avenue to pursue in the future.
Chipotle’s balance sheet has an approximate liquidity of $152m at the end of the quarter. Typically companies with such strong cash positions would begin to think about share repurchase plans or dividends. However, right now CMG cannot use cash to this effect as that would jeopardize the tax-free status of the company’s spin-off from McDonalds. Instead, the company will use the cash to fund new store openings and continue its aggressive growth strategy. New store openings throw off a 40% ROI and remain the company’s best use of cash. Additional capital can be spent for measures that drive efficiencies such as a new hand-held POS system which allows staff to charge customers while they are standing in line which decreases the wait time and increases the number of customers able to be served during peak lunch hours. Investors have asked management to consider a drive-thru, which it has thus far negated as a drive-thru may erode the existing experience.
Fast Casual
The fast casual segment remains the fast growing slice of the restaurant sector and its “middle ground” status provides a compelling alternative for both customers aiming to stretch their dining dollars (average check is $7-10 vs. > $10 at full-service and < $7 at limited service/fast food) and investors looking to park cash among differentiated companies that can survive the stagflation cycle. Customers in this segment expect food quality that is in line with a sit-down restaurant but with speed and convenience of fast food. The National Restaurant Association (NRA) is forecasting a 5% increase in fast food sales in 2007 (2.1% adjusted for inflation) to $150.1 B from $142.9B, an increase similar to that seen in 2005 and 2006.
Whole Foods Effect
The company is well positioned to capitalize on the “Whole Foods effect” and secular drive towards high quality ingredients. According to the organic Trade Association (OTA), organic food sales are growing at a 20% clip annually in the US, although such food only accounts for 3% of all food and beverage sales. The company is ambitiously redefining the way America grows, serves, and eats its food. Most of the food is made fresh daily: its people chop fresh tomatoes, pull oregano leaves off stems, and toast cumin seeds. Among its suppliers, Chipotle avoids meat from livestock raised with hormones or antibiotics and looks for fresh ingredients naturally raised with respect to the land, animals, and farmers that produce the food.
Chipotle, seems to have created a sustainable branding strategy that leverages its good food, humorous ads, distinctive interior design, and in-store world music. It is a testament to Chipotle’s success that they have built a purpose bigger than its product and accomplished so without any finger-pointing.
Share Classes
Chipotle has A and B-shares of stock. The B shares represent 1:1 ownership when compared with A shares, but have enhanced voting rights. Despite this, the B shares have traded lower than the A shares consistently, as of November, 2008. The price spread between A and B shares is an example of an arbitrage opportunity, as well as evidence that strong form Efficient markets hypothesis is not observable in real markets.
References
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