Investment Conclusion
Chipotle Mexican Grill (NYSE:CMG) is scheduled to report F1Q2022 earnings on April 26, 2022, following market close. The average consensus revenue and earnings per share estimates for the quarter are ~$2.01 billion and $5.68. Based on our analysis, it appears likely that the company’s actual financial outcomes will come in ahead of analyst estimates for the period. Our conviction is driven by several incremental revenue growth opportunities available to CMG, including, higher staffing levels, recently enacted price increases and menu innovation, as well as above normal growth of the footprint over FY2021.
In addition, we were highly impressed by the firm’s F4Q2021 financial results. Fueled by a strong rebound in dine-in sales and continued growth in digital sales, system sales and same-store sales experienced double digit growth on a year-over-year basis. Further, revenue leverage and an increase in menu prices implemented in December, fueled a year-over-year improvement in restaurant level operating margins. During the period, the company opened 78 new stores , 67 of which are equipped with Chipotlanes. Moreover, management updated its target restaurant footprint to 7,000 stores from the previous 6,000, to include the opportunity it now believes is available in small towns across America. Furthermore, in January, CMG debuted an additional protein option for its burritos and bowls, in form of vegetarian Chorizo, available as a limited time offering.
For the first quarter and the rest-of-the-year, we expect business momentum had been/will be sustained, as improved staffing levels reflect in reduced order preparation time for dine-in/digital orders, resulting in an increase in sales. In addition, given that the loyalty program comprised of ~26.5 million members at the end of the fourth quarter, we expect the feature to deliver significant incremental revenues. Further sales growth will be derived from footprint expansion with between 235 to 250 new stores (of which 80% will have Chipotlanes) expected to be launched in FY2022. Factoring in the 4% price increase enacted in December, and lower marginal fixed costs due to revenue leverage from sharply higher sales, we anticipate margin expansion at the restaurant level and corporate level, despite commodity cost inflation. Based on potentially higher revenues and margins, profits and free cash flows will surge over the near-term, in our opinion.
For F1Q2022, management has guided to year-over-year same-store sales growth of mid-to-high single digits, and normalized restaurant margins of ~22%. In addition, CMG indicated that additional increases in menu prices will be implemented in case costs of key items it utilizes to prepare its products continue to surge. Moreover, the company believes that, given the quality and quantity of its menu offerings, customer demand for its food is price inelastic. For the remainder of FY2022, we believe that CMG will continue to outperform its broader industry, with financial results for the most part replicating that expected of F1Q2022.
Longer-term, CMG’s planned growth in footprint to 7,000 restaurants within ~10 years, from the current ~3,000 will drive the majority of growth. Given that the massive expansion in the number of restaurants is likely to be focused on under penetrated regions, we do not expect cannibalization in sales or declines in average unit volumes, as new units are established. Additional growth will be derived from an increase in same-store sales attributed to: Chipotlanes, menu innovation, the loyalty program, some conversion of dine-in orders to digital, and the continued growth of off-premise sales. Given the potential significant expansion in sales, margins are likely to increase as marginal fixed costs decrease substantially and economies of scale related to advertising and the digital platform are secured. As a flow-through of higher sales and improved margins, we expect substantial growth in earnings and free cash flows over an elongated time horizon.
We are adjusting our 10-year Discounted Cash Flow model to account for the shift in the 10-year new unit development plans. Specifically, we are increasing our 10-year revenue growth rate to 17% from the prior 16%, which incorporates a 10-year unit count of 7,000, and average unit volumes of over $3 million. Based on the changes, we arrive at our new 1-year Price Target of $2,020/share versus the prior $1,849/share. Reiterate Buy Rating. (Please go through our initiation report “Chipotle Mexican Grill: Turnaround Story With Substantial Growth Potential” and related notes for our long term opinion on the stock).
Key Takeaways From The Fourth Quarter
F4Q2021 Results Summary. For the quarter, CMG reported revenues of ~$1.96 billion (+22% compared to F4Q2020) inline with analyst expectations, and earnings per share of $4.69 (-29.9% on a year over year basis) below consensus estimates of $5.29. Excluding extraordinary items, earnings per share would have been $5.58, representing an increase of 60.3% from F4Q2020. In addition, compared to the same quarter last year, same-store sales increased by 15.2% over the fourth quarter. Net income for the period was ~$133 million reflecting a decline of 29.9% on a year-over-year basis. Restaurant margins of 20.2% expanded by 70 bps compared to the prior year’s same quarter.
Target Store Count Raised to 7,000 Stores. Based on a recent change in strategy to diversify into small towns in the U.S., CMG announced that it now expects to expand its North American restaurant footprint to 7,000 from the prior 6,000. In that regard, the firm believes it can achieve the objective by growing the restaurant base at an annual rate of ~8%-10%, with a focus on the top part of the range. ~80% of the new units are expected to be built with Chipotlanes. Given the growth objective, CMG should have 7,000 stores in North America by 2032.
With respect to new unit development in small towns, it is noteworthy that CMG’s existing restaurants in such areas not only additionally benefit the firm’s bottom-line, as they generate higher than average sales volumes, and better margins, due to lower fixed costs, but are also relatively easier to staff as the firm appears to be an employer of choice in rural regions. Therefore, considering these factors, it appears that the strategy to derive growth from small towns is likely to succeed. As per management, there is an opportunity to launch ~1,000 stores across small towns. Overall, a prudent maneuver, to capture low hanging fruit, in our judgment.
Digital Sales Well-Positioned For Additional Growth. During F4Q2021, CMG’s digital sales expanded by ~4% on a year-over-year basis to ~$811 million, representing ~42% of total sales. For FY2021, digital sales advanced to ~$3.4 billion, 3.5x that experienced in FY2019. Clearly, digital sales have been vital to the growth CMG has experienced over the last couple of years.
Nevertheless, despite the strong advancement, the company’s digital sales growth appears not only sustainable but well-positioned for additional growth.
That currently ~2/3rd of CMG’s customers exclusively utilize the in-store channel to access the firm’s food and that a significant fraction of this group at some point in the future is likely to begin placing orders through the digital platform drives our conviction that digital sales are well-positioned to advance further.
Additional escalation in digital sales will accrue from the growth of the loyalty program, as it mandatory for customers redeeming their rewards points for free food to place orders using the digital platform. In that regard, it is noteworthy that the loyalty program with ~26.5 million current members is already a significant resource for digital sales.
Digital sales, specifically the order ahead and pick-up transactions generate the highest margins of all order types. Moreover, customers that utilize the digital platform for placing orders, typically transact more frequently and with higher check values.
Focus On Chipotlanes Continues To Deliver. Considering that restaurants with Chipotlanes consistently experience above average customer traffic which reflects in 15% to 20% higher sales volumes than restaurants without the feature, CMG’s strategy to rapidly expand the number of Chipotlanes it operates appears prudent. That it requires only ~$75K to build restaurants with Chipotlanes that typically generate two-year cash-on-cash returns of 65% to 70% versus the 55% to 66% derived from establishments that do not include Chipotlanes, further bolsters the investment case in favor of Chipotlanes. In addition, the element provides the firm an opportunity to open Chipotlane only restaurants in small towns and even Expressways, with limited development costs. Given the significant benefits associated with Chipotlanes, the feature appears well-positioned to drive growth over an elongated time horizon. At year-end FY2021, 355 of CMG’s ~3,000 restaurants included Chipotlanes. In that regard, the firm added 174 Chipotlanes in FY2021, 67 in F4Q2021, and expects >80% of its FY2022 new unit development to be built with the element.
Menu Innovation Remains Key Focus. Consistent with its strategy to launch two to three new menu items on an annual basis, over the prior year, CMG launched one permanent item, the quesadilla, and two limited time offers, Cauliflower Rice and Smoked Brisket. Year-to-date, the company has introduced vegan Chorizo, as a protein option, across its stores in the United States, as a limited time offer. In addition, Pollo Asada, CMG’s first update of its chicken, has surpassed the stage-gate process, and will likely be launched during the year, on a national basis. Based on updated company news, Pollo Asada was debuted as a limited time offer in the U.S. and Canada on March 10.
Given that based on historical data, it appears that new additions to CMG’s menu offering, typically result in an uptick in new customers and encourages existing customers to visit its stores, that the firm remains focused on menu innovation will reflect favorably on its sales and profits, this year.
Balance Sheet Remains Solid. At the end of F4Q2021, the company had a cash and cash equivalents balance of ~$815 million and no long-term debt on its balance sheet. CMG can borrow an additional $500 million to fund operations under a credit facility, it has available. During the period, the firm increased its share repurchase program by $200 million, and bought back ~$169 million worth of shares at an average price of $1,750. Given its funding position, we believe that CMG will handily maintain liquidity over the final months of the pandemic.
Bottom Line
There appears little that could stop CMG now. Backed by solid customer demand for its “made from real ingredients” food, a profitable business model, and significant white space to grow the footprint, both domestically and internationally, the company is a cash-cow, albeit the kind with considerable growth ahead of it.
Given the intrinsic strength of the business, the threat to CMG will have to be external, chiefly competition and/or cost inflation linked to commodities and labor. Although, the firm appears to be navigating inflationary headwinds efficiently, CMG has enjoyed a relative competition free business environment since its inception. Nevertheless, the substantial first mover advantage the organization underpins, provides it a safety moat, that is most likely unbreachable.
Overall, CMG appears well positioned to keep returning substantial returns on shareholder investments for numerous years.
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