Chipotle Is a Top 10 Stock
Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It is important to focus on great businesses when developing a list of top companies for an investment portfolio. Aside from the common traits of great management and a solid financial position, great businesses have an easy to understand investment thesis that the investor both understands thoroughly and has confidence will play out over the long term. These traits are all solidly present in the fourth stock on my personal "top 10" list, Chipotle Mexican Grill (NYSE: CMG).
Invest in what you know ... in this case, a great tasting burrito
The investment thesis for Chipotle is simple to understand and is in many ways similar to the thesis behind the No. 1 stock on the top 10 list, Apple. Consider this: Chipotle focuses on "food with integrity," which seeks to find the best ingredients to create a differentiated product that is so well received that it commands premium pricing compared to the competition. Sound familiar? In addition to premium pricing, demand has allowed Chipotle to maintain higher margins by avoiding the need to discount its products.
Additionally, Chipotle started life as a domestic, one concept company (i.e. burritos). While it has been tremendously successful in growing this concept domestically, the real growth opportunity going forward lies in international growth and the successful testing and roll out of new concepts such as Shophouse. While this might be where the similarities between Chipotle and Apple end, this model serves as the foundation for the investment thesis for both companies.
As is the case with Apple, the growth story at Chipotle is nowhere near complete. Analysts expect Chipotle to reach domestic market saturation somewhere between 3,000 and 3,500 locations. At just 1,350 stores today, this leaves tremendous room for continued expansion domestically.
Additionally, Chipotle has significant opportunity to further increase the number of locations its operates through international expansion; to date, the company has opened just 10 restaurants internationally in London, Toronto, and Paris. New store openings in Germany and Vancouver, Canada are already on the horizon with more to follow.
A third channel for growth is the expansion into creative new restaurant concepts. While the magnitude of this opportunity is far less certain at this time, Chipotle is perfecting its Shophouse Southeast Asian Kitchen concept in Washington D.C. with plans to roll out a second location in the city as well as a third location in Los Angeles.
Growth also comes from the growing base of existing locations, where increases in same store sales, or SSS, will continue to fuel growth. While Chipotle's third quarter results concerned investors with a drop in SSS, the 5% increase reported by Chipotle is higher than many of its peers and is not necessarily a long-term trend. Plus, there are additional growth opportunities that Chipotle hasn't even attempted to unveil thus far, including a breakfast menu that would allow Chipotle restaurants to remain open for longer hours -- similar to fast casual peer Panera Bread (NASDAQ: PNRA).
An attempt to apply a simplified valuation model to all of these growth drivers can be found in a July post on this topic. Updates to the assumptions in this valuation due to Chipotle's recent results and the decline in share price indicate a range of various outcomes that will generate improved returns for investors at today's prices. In short, Chipotle's price to earnings ratio can compress to 15 or 20 and the stock can still yield a CAGR of between 5% and 14% over the next 10 years. Translated into plain English, a reasonable set of assumptions can justify a share price target of $1,022 in 2022 assuming Chipotle's continues its current trajectory.
Competition is everywhere
The key risks to the investment thesis for Chipotle are the macroeconomic environment (which affects all companies) and direct competition. Much attention has been given to David Einhorn's bet against Chipotle, which emphasizes the competitive threat of Yum Brands' (NYSE: YUM) recently unveiled Cantina Bell menu at Taco Bell. While the market seems to give this short thesis significant attention, the fact remains that most people who currently frequent Chipotle are not likely to switch allegiances to Taco Bell; the ingredients are not as fresh, the taste is not as good, there is no attempt to attach a message of environmental responsibility, and Chipotle customers have never had an issue paying a premium price for a better meal. However, consumers without a convenient Chipotle or sensitivity to price are likely to be drawn toward Taco Bell's improved menu.
Competition is wide spread, ranging from fellow burrito makers such as Jack in the Box's (NASDAQ: JACK) Qdoba restaurants, comparably-priced fast casual restaurants such as Panera, and in certain cases fast food chains such as McDonalds (NYSE: MCD) and Taco Bell. The fact is that there is no shortage of choices for fast food, fast casual and casual dining experiences. Thus far, Chipotle has excelled competing in this environment. To provide context on the competitive environment, QSR's list of the top 50 quick service restaurant chains by domestic revenue yields interesting information. Here are a few anecdotal highlights:
- McDonalds, the No. 1 chain on the list, generates more revenue from the sale of happy meals than Panera (No. 13 on the list) generates in total.
- Taco Bell, the No. 6 on the list, is roughly five times the size of Chipotle by restaurant count.
- Chipotle, No. 18 on the list, generates roughly 50% more revenue per location than Taco Bell. Interestingly, Chipotle is also the only restaurant in the top 40 with no franchised locations; this is not only an impressive achievement for a company with no debt, but also a key competitive advantage in ensuring a consistent food quality and customer experience across the company.
In addition to the opportunity to continue to grow Chipotle's restaurant count towards 3,000 domestic locations, this list also indirectly highlights the reason why Chipotle is somewhat insulated from the threat of fast food offerings from McDonalds and Taco Bell.
With domestic restaurants totaling roughly 14,000 and 6,000, respectively, McDonalds and Taco Bell have rolled out locations everywhere from high-end neighborhoods to run-down gas stations along the highway. In contrast, Chipotle is deliberately identifying areas with appealing demographics, taking a methodical approach to selecting ideal locations, and leveraging its expertise in rolling out successful company-owned locations.
A successful concept, deliberate location selection, the financial commitment to success of company-owned locations, and the consistent quality that can be assured by eliminating the middleman franchisee is a recipe for continued success.
So why is Chipotle a buy today?
The investment thesis described at length above hasn't really changed for years. Each quarter, management makes steady progress in growing its restaurant count, generating strong SSS, and maintaining high margins despite economic pressures from both consumer spending and rising food costs. However, Chipotle's year-to-date share performance of -19% has caused investors to panic rather than take note of the fact that the recent decline in share price has created an attractive value point for purchasing shares. While a TTM P/E of 32 and a forward P/E of 26 (based on the December 10, 2012 closing share price of $272.92) may not be cheap, it is certainly much more attractive than the TTM P/E of over 50 that became the norm earlier this year. Plus, this valuation is very reasonable for a growth company with no debt, TTM revenue growth per share of 28%, and TTM earnings growth per share of 34%.
For an investor who buys into the growth opportunities that remain on the horizon for Chipotle, the market has provided an opportunity to acquire shares at a much better valuation than has been available at any time since the great recession.
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BrewCrewFool owns shares of Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill, McDonald's, and Panera Bread. Motley Fool newsletter services recommend Chipotle Mexican Grill, McDonald's, and Panera Bread. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!