What Will Boost Growth of This Food Retailer?

Gaurav is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It is true that Chipotle Mexican Grill (NYSE: CMG) is keeping market watchers busy speculating whether its growth story is slowing. The rise in food inflation, modest same store sales growth and growing competitive pressures are raising questions on the company’s premium valuation.

But my take is that there is still upside left for Chipotle. The company has enough room to grow sales by tapping more markets at home and overseas.

These trends are visible in the first quarter numbers where revenue increased 13.4% driven by new outlets and fueled a solid earnings growth of 24.4%.

Expansion of stores in US

There is no doubting the fact that Americans love Chipotle. Its ‘Food with Integrity’ has struck the right cord with a population that is increasingly opting for healthier food options even if they have to dish out a few extra dollars.

This paves the way for the company to increase its count of restaurants significantly over the coming periods. And Chipotle seems to be doing just that. It opened 48 new outlets in the first quarter of 2013, which brings its restaurant count to 1,458. This is approximately 10% of the number of McDonald’s in the US. So there is still huge room for growth.

In 2013 Chipotle plans to open 165-180 outlets, out of which 40% will be constructed in new real estate and the remaining 60% on remodeled sites. Last year it opened 200 restaurants.

Demand will grow

Slowing comps have been worrisome in the first quarter when Chipotle posted just 1% growth in same store sales. However this can soon change. Although it is unlikely that the company will return to double digit growth that was the case even about a year back, improvements in comps are inevitable over the coming quarters.

First of all Chipotle is making some interesting additions to its menu. Its experiment with a new spicy tofu based item cooked with roasted peppers and called ‘Sofritas’ has created a lot of buzz in San Francisco bay area. A national launch may not be far off. The chain has also introduced a premium Patron Margarita from end April priced at around $6.50 to $8 depending on the location. These new items should be crowd pullers over the coming months.

Next, Chipotle has recently launched its catering service, which allows customers to use portable version of the chain’s services for groups as small as 6 and as big as 200.

Given that peers like Panera Bread (NASDAQ: PNRA) and Qdoba Mexican Grill owned by Jack in the Box (NASDAQ: JACK) derives around 7-8% of their revenue from catering service, this would be an important line of business for Chipotle too. The company currently offers catering in some 14 states, but Chipotle has planned to expand this service nation-wide by the end of the third quarter of 2013.

Finally, the company is improving its brand awareness through meaningful promotions. It recently hosted day long ‘Cultivate Festivals’ at San Francisco, Denver and Chicago to spread awareness of local and sustainable farming. These festivals hosted by Chipotle come with attractions like live demonstration by celebrity chefs, live music, local beers, and special festive menu from Chipotle’s kitchen. The company has raised its marketing budget from 1.3% of sales in 2012 to 1.7% in 2013.

Penetrating Untapped World Markets

Chipotle has just 12 restaurants outside the US. There are about 5 in Canada, 6 in London, and 1 in Paris. According to a survey conducted in London only 1% of survey takers knew about Chipotle without prompting as compared to 23% for McDonald’s. The chain is yet to foray into Asia. So there is the whole world out there waiting.

It is true that the task is challenging given that Chipotle has to tread cautiously. It owes its success to its superior food quality which in turn means excellent supply chain management. So, new markets can only be added when the company finds appropriate suppliers and this is often difficult. The food scandals surrounding Yum! Brands in China on account of supplier issues are cases in point.

Never-the-less international expansion remains a key factor for Chipotle for fueling growth.

Competitive pressures

Chipotle faces competition from fast casual chains as well as traditional Quick Service Restaurants or QSRs.

So on one hand there is McDonalds, Burger King and the like and on the other hand there are chains like Panera which are also tapping the health awareness wave. But the company’s closest rival is Qdoba Mexican Grill, which offers fare similar to Chipotle. Let us examine Panera and Qdoba and see how they are faring.

Panera is attracting footfall through its newly introduced pasta menu as dinner option along with addition of chips and shrimp to its existing menu. The chain posted good first quarter results although revenue fell short of analyst expectations. Revenue increased 13% to $561.8 million against analysts' estimate of $566 million. Earnings increased 17% to $1.64 per share.

Panera reported lower comps in the first quarter which dampened investor enthusiasm somewhat. Its same store sales growth came in at 3.3% at both company-owned and franchised restaurants, which was below its own guidance of 4-5% at company-owned outlets. Panera attributed this to bad weather. It is now looking to fuel growth and has planned to increase its marketing spend by 30% in 2013.

Meanwhile, Jack in the Box too could not do justice to its guidance of 1-2% comps growth in its Qdoba chain in the recently reported second quarter. Same store sales growth declined 1.5% at Qdoba with both company owned and franchise stores contributing to the decline.

Again weather was considered the main culprit although the key factors are possibly the weak eating out environment and competitive pressures.

The chain is however expanding its presence in the country. It opened 15 new locations during the quarter, which brings the count of total Qdoba restaurants to 647. The company has plans of adding 70-75 Qdoba outlets through fiscal 2013.

Last Word

Chipotle’s naturally raised meat, innovative menu, warm reception, and nice interiors have created a strong brand in the fast casual segment. With more promotions, new menu options, and its catering service the company will further augment its appeal. Meanwhile it will usher in growth through domestic and international expansion. Considering these facts I think Chipotle’s valuation is justified and investors can expect more upsides in the future. 

Chipotle's stock has been on an absolute tear since the company went public in 2006. Unfortunately, 2012 hasn’t been kind to Chipotle’s stock, as investors question whether its growth has come to an end. Fool analyst Jason Moser’s premium research report analyzes the burrito maker’s situation and answers the question investors are asking: Can Chipotle still grow? If you own or are considering owning shares in Chipotle, you’ll want to click here now and get started! 

Gaurav Basu has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill and Panera Bread. The Motley Fool owns shares of Chipotle Mexican Grill 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!

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