Chipotle Is The Best Brand In The 'Fast Casual' Restaurant Space

Not gonna lie, today's Green Screen stock review choice was mainly because... I LOVE this company!

I'm sure many of you are the same. Hardly a week goes by where I don't have my Chipotle (CMG) burrito bowl - double chicken, please. In fact, few weeks have gone by since about 2008 when I first discovered the chain! Maybe in 2015 and 2016 during the food illness outbreak... but even then, I never avoided the place. It is easily the best of the fast food chains out there today. Always consistently delicious!

So, it was quite exciting to see it pop up on the "Tortoise" side of the Green Screens several weeks ago. Could this be a good stock to add to the Watch List and, potentially, even own?

It's exciting to consider, but we have to be cooly logical as well. Restaurants are one of the most notoriously difficult businesses in the entire world. Only a very select few chains have weathered all the challenges and reached anywhere close to Chipotle's lofty $50 billion market cap. In fact, there's only one that's larger - McDonald's (MCD), with a $190 billion valuation!

Let's take a closer look and see if Chipotle is worth taking a bite of.

The Business

One nice thing here is that this is a simple business to understand. Chipotle has roughly 3,250 restaurants, all but 53 of them inside the U.S. It owns and operates all of its locations - no franchising here! As most of you likely know, the company serves burritos, burrito bowls, and tacos on a fully customized basis from a limited number of ingredients.

While about 60% of orders are in-person, Chipotle was a pioneer in online ordering and quick pickup. Close to 40% of orders are placed and paid for through its mobile phone app, then picked up off a shelf from the store or delivered. This was a huge boon during the COVID pandemic, when close to half of sales came from online! Online is so important that Chipotle is developing the bulk of its new locations with "Chipotlanes", which are simply drive-thru pickup lanes for completed online orders. Super convenient!

The Revenue Growth and Recurrence Story

Despite being in business for 3 decades, Chipotle continues to grow revenues impressively, with a 3 year CAGR of 15.6%.

Growth will come from two places: new store locations, and increased same store sales from existing locations. On the new store front, management estimates it has a 7,000 unit opportunity in North America. Over the last several years, the firm has opened about 200-250 stores a year, about 6-8% store growth. Management has indicated it plans to accelerate that pace to 8-10% store growth annually. That alone is a pathway to strong annual sales growth for the next decade before saturation.

As for same-store sales, Chipotle has been very successful in inching up pricing, allowing impressive 7-8% growth figures over the last couple of years. I wouldn't expect this to continue unabated, but 3-4% annual increases doesn't seem out of the question, given customer's obsession with the brand.

That would put the annual sales growth rate in the low teen's percentages - not spectacular, but very good for this large of a chain. Longer-term, international expansion and perhaps new concepts are options to extend the growth runway. We're looking for double-digit revenue growth here - Chipotle passes muster.

As for recurring revenue, I think it is "close enough". Certainly my family pays Chipotle on a regular basis (several times monthly, if not weekly), and I'm pretty sure we're not alone. While the recurrence of revenue isn't structural here, frequent repeat purchases are without question a key component of the business.

Is There A Moat?

It is nearly impossible for a restaurant to earn a moat. Competition is intense and widespread. There are no switching costs for consumers. Scale isn't much of an advantage because company-run restaurants are a sum of unit economics.

About the only possible moat factor here is a familiar one in the consumer space: brand. A really strong restaurant brand can either allow a firm to charge more than competitors for essentially the same product, or become a "default choice" for consumers in a jungle of options.

Chipotle has been able to push through consistent price increases - but not substantially more so than competitors like Qdoba. No, what really solidifies Chipotle's brand is its status as a "default choice" to go for quality food, fast.

To be sure, this is hard to quantify. The best you can point to is a 30 year history of successfully opening new stores and delivering consistent same-store sales growth. Clearly, hungry consumers continue to choose Chipotle instead of the Wendy's, or Burger King, or dozens of other options just next door.

Another good illustration is how the firm has bounced back from food safety issues in 2015-16 that would have put a lot of weaker chains out of business entirely. Despite this, Chipotle is as strong now as ever.

Only a few restaurants can claim a true brand moat. McDonald's, Starbucks... maybe Chick-fil-A? Chipotle fits in that group. I wouldn't consider it an extremely wide moat, but it's a brand that has survived and thrived. There's something there that keeps people coming back, for certain, and it has been sustainable.

Management and Financials

Brian Niccol is CEO since 2018, and added the Chairman of the Board role in 2020. Previously CEO of fast food chain Taco Bell, he took over for founder Steve Ells after a series of food-borne illnesses struck the chain in 2015 and 2016 (Ells has since left the company).

Chipotle's turnaround under Niccol has been impressive, especially considering the COVID pandemic in 2020-21 that devastated many restaurants. Sales have increased over 15% annually, and free cash margins have nearly doubled, from 8.6% in 2018 to 16% in the past 12 months. Niccol during his tenure has won numerous awards, including Fortune's 'Businessperson of the Year', a spot on Barron's Top CEOs list, and 'Leader of the Year' by Restaurant Business magazine, just to name a few. At 46 years of age, he has a long tenure ahead of him if he wants it.

As restaurant chains go, Chipotle's financial metrics are top-notch. We've already mentioned its strong cash profitability. The firm is debt-free with over $1.7 billion in cash on the balance sheet - pretty impressive in such a capital intensive business. Cash return on investment stands at nearly 27%, also quite impressive. This is an industry where single-digit margins and sub-10% ROIs are the norm.

Recently, the firm has even begun to buy back shares, and has nearly $300 million in authorized repurchases as of the end of Q2 2023.

Chipotle's management and financial condition are strengths. No issues here.

Risks

Compared to our typical recommended stocks, Chipotle would be considered on the higher risk side.

The company knows all too well about the risks of food safety and food-borne illnesses on its business (and stock). So far, it has managed to survive some serious hits. But I'm not sure another major outbreak can be tolerated without doing lasting damage to the brand.

Then there are all of the typical challenges in the restaurant business. Labor and food costs are volatile and unpredictable. Labor availability has proven challenging for years. Disruptions in supply chain for Chipotle's limited number of ingredients has cost it business in the past and will again in the future.

Conclusion

Although it is far from a slam dunk, Chipotle makes the cut into the "green dot" stock Watch List. There is a clear path to 10-12% annual sales growth, revenues are reasonably if not structurally recurring, the consumer brand moat is undeniable, and it has strong leadership and financial strength. It takes a LOT for a restaurant to pass muster with me - I'm the guy that rejected Starbucks! Chipotle makes it in, but just barely. It will need to continue operating at a high level, because things can go south at restaurant chains very quickly.

That decided, what is a good price on the stock? I've modeled for about 12% growth, a 0.5% annual buyback, and a 13.5% free cash margin over the next 5 years. The discount is 11% - slightly above my "par" of 10.5%, as I think restaurants are naturally riskier businesses. The fair value price comes out to $1,424, a fair bit below the $1,800 the stock currently trades at. We will add Chipotle to the Watch List today and keep an eye out for better prices going forward.