What Is a Better Strategy for Chipotle?

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

Chipotle Mexican Grill (NYSE: CMG) has always been a favorite with food lovers on account of its healthy menu. The company uses more naturally raised meat than any other fast food chain in the US.

However, of late the sales trends have come down from the levels with which we have always associated Chipotle. It did beat earnings estimates in the first quarter but it needs to do more to justify its valuation. The company reported earnings of $2.45 per share against consensus estimates of $2.14 per share. The stock is trading at 28.58 times its forward earnings.

Presently, Chipotle is trying out various strategies and options. But will any of these moves brighten its long-term prospects? Let us take a closer look to see if we can find any winning strategies.

Strategy 1: Store expansion

Chipotle is expanding its store base to compensate for its soft same store sales growth. This is evident in Chipotle’s first quarter results. There was a sizable revenue growth of 13.4% to $726.8 million while comparable stores sales were up by just 1%.

What is significant is that the company opened 48 new outlets in the first quarter alone and is planning to open a total of 165-180 outlets through the year. And this comes after 200 new store additions last year.

This is not a bad strategy if you consider the competitive pressures that have left most fast food chains struggling to grow their comps. Even McDonald’s has reported a 1% decline in its US same store sales in the most recent quarter. However, Chipotle needs to focus on growing its sales from existing stores as this has a direct impact on profitability.

This takes on an added dimension if you consider that the company is in any case facing a margin squeeze on account of the rising food costs. Currently, food costs account for one-third of the total revenue. The situation has almost come to a point where if Chipotle raises prices it risks losing its customers and if it doesn’t its margins go for a toss.

Strategy 2: New Brand

Chipotle is launching its second brand, ShopHouse Southeast Asian Kitchen where it would be serving oriental fare like noodle bowls, curries, and stir fries. The first ShopHouse outlet opened in Washington, DC, in September 2011 and now the company is planning to open three more over the coming months.

Again there is nothing wrong with the strategy per se. But Chipotle is still a relatively new brand and any wrong moves with the new ShopHouse brand can negatively affect the core business. So instead of trying to build a fresh brand with a completely new cuisine it might have been better if the company had stuck to what it does best and that is serve excellent quality Mexican fare.

And if it had to diversify, international expansion of the core chain was always a good option. The company has only 12 restaurants outside the US and has not even ventured into Asia where the entire band of fast food players is setting up shop. Yum Brands! (NYSE: YUM) introduced Taco bell restaurants in China way back in 2003.

Strategy 3: Menu Expansion

Finally let us talk about the recent menu expansions that are happening at Chipotle. There are two new things on the horizon that look exciting.

The company is introducing a new premium Patrón margarita which will hit the menu from end of April. This is an exciting possibility as not many fast food outlets offer alcoholic beverage option. However, this is not a new concept for Chipotle as it already serves margaritas. But what is new is that instead of using a ready-made mix to stir up the drink the company will now hand-make them using simple ingredients.

This is exactly the kind of innovation that should work. Adding a twist to existing offerings can make the fare much more interesting without too many teething issues. And not to mention that the drink priced at $6.50 to $8 depending on where you are placing the order, should add to the bottom-line as well.

Chipotle is also planning to add a new vegetarian option in the form of Sofritas or spicy tofu and is aggressively testing this out. It launched the Sofritas in San Fransisco in February and currently testing the item in Northern California.

Given that the company so far had only black beans burritos as a vegetarian protein option this new addition should nicely round up the menu offering.

Competitive pressures

Chipotle typically goes neck to neck with Qdoba Mexican Grill, owned by the hamburger chain Jack in the Box (NASDAQ: JACK). Both restaurants operate in the fast casual space and serve similar Mexican fare of burritos, tacos, salads, chips, and salsas.

They are also seeing similar trends as far as comparable stores sales go. In Chipotle’s 2012 fourth quarter which almost coincided with Qdoba’s 2013 first quarter, both chains saw comparable stores sales growth of 3.8%. Subsequently, in the current quarter Chipotle has posted 1% comparable stores sales growth while Qdoba has guided for 1-2% growth.

Despite the similar trends, Chipotle definitely has an edge over Qdoba. It has been well established that the food, service, and interiors at the former are better than the latter. In a recent report by food researcher Technomic it was held that Qdoba lags Chipotle as a brand. They rank 3 and 2 respectively after Moe's Southwest Grill which was adjudged the best fast food chain in the Mexican space.

Besides competing with each other, both Chipotle and Qdoba are facing unforeseen competition from Taco Bell. With their superior quality food and well done interiors they never expected that Taco Bell could become a threat. But the latter has made a heavy impact with its Cantina Bell and Doritos Locos Tacos line of burritos.

The recently launched Doritos Cool Ranch has become an instant hit. While the quality is not the same as Chipotle, it is a much pocket friendly option. You can get a Doritos Cool Ranch for less than $2 while a Chipotle burrito will not cost anything less than $7 for basic options. And one does not compromise hugely on the taste either.

The results are clearly visible from the 6% same store sales growth the chain has just reported for the first quarter.

Last word

Chipotle is trying out many strategies to fuel long term growth. While store expansions and launching a new brand have their own merits, I think expanding menu options is the best thing that the company has done. The new food and drink options would rekindle the interest in Chipotle’s menu. This will drive comps and also help margins.

Eshna De has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. 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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