Superior Management a Key Ingredient to Chipotle's Success
Steve is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When considering a potential new investment like Chipotle Mexican Grill, Inc. (NYSE: CMG), I first conduct due diligence on the capability and integrity of the management team, even before digging into the financials to examine revenue growth, profit margins, cash flow, and debt levels. Because it implements strategy and allocates the company’s capital, evaluating the management team is crucial to estimating a company's prospective long-term results. The presence of a capable and shareholder-friendly management team gives investors confidence that past operating success will continue into the future and lead to continued shareholder gains. To evaluate management, I look at how closely their interests are aligned with the shareholders' interests, the returns on investment that they have produced, and the total compensation they have taken for their efforts.
The first measure that I assess is how closely the senior managers’ interests are aligned with mine as a shareholder. The key insiders of Chipotle, which as a group includes five executives and five independent directors, hold 1.7% of outstanding shares. This percentage of ownership is better than two of Chipotle’s fast casual restaurant competitors, Jack in the Box, Inc. (NASDAQ: JACK) and Panera Bread Company, Inc. (NASDAQ: PNRA) at 1.4% and 0.8%, respectively. The holdings of the key insiders of Chipotle are down over the past 12 months so this factor rates as neutral to good for Chipotle.
A second measure of management is their ability to produce returns on invested capital. Chipotle scores very well as return on invested capital (ROIC) has steadily improved to more than 23% in 2011 from 13% in 2008 and 2.7% in 2004. The average ROIC has been 14.8% since 2004. It is also very bullish that the company has achieved this without long-term debt, so return on equity has matched ROIC. By contrast, Jack in the Box and Panera have generated average ROIC of 10.9% and 16.7%, respectively, since 2004. In 2011, ROIC was 9.2% for Jack in the Box and 21.7% for Panera. Chipotle’s upward trend and most recent annual ROIC distinguish it among its peers.
My last test of management is the total compensation the company’s managers have taken in comparison to revenue growth, returns to shareholders, and compensation taken by similar competitors. Chipotle’s compensation of key executives increased by an average annual compound rate of more than 36% from 2007 through 2011. Given that the share price rose by 43% compounded annually over the same time, this growth in compensation is reasonable. Note that there are no dividends, thus the return to shareholders is solely from share price appreciation.
The company’s compensation appears less beneficial for investors, however, when considering revenue growth. Chipotle’s compensation has increased to 2.2% of revenue in 2011 from 1.3% in 2007, while Jack in the Box's compensation was 0.5% of revenue in 2011 and 0.2% in 2007 and Panera's compensation was 0.6% of revenue in 2011, up from about 0.2% in 2007. While lower management compensation as a percentage of revenue at Panera and Jack in the Box would seem to be better for investors, these lower payout rates are appropriate for their managements because their share prices have lagged Chipotle. Jack in the Box saw its shares decline by more than 7% compounded annually between 2007 and 2011 while Panera's shares rose by more than 20% compounded annually during that time, compared to 43% annually for Chipotle.
Overall, it appears that Chipotle's management has its interests in line with the shareholders. They generally satisfy my standards for integrity and capability, thus the company is a good investment candidate that merits further due diligence regarding the attractiveness of its financial position and operating results. Despite a big increase in share price to a recent $417 per share, which is near an all-time high, the quality of the company’s management leads me to believe that Chipotle may be well positioned to continue rewarding shareholders through rising intrinsic value. In a future posting, I will examine the company’s operating metrics including revenue and cash flow growth, profitability, debt levels, and working capital efficiency to assess the prospects for continued share price appreciation.
56Steve has no positions in the stocks mentioned above. The Motley Fool owns shares of Chipotle Mexican Grill and Panera Bread. Motley Fool newsletter services recommend Chipotle Mexican Grill, Jack in the Box, 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.If you have questions about this post or the Fool’s blog network, click here for information.