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The following segment was excerpted from this fund letter.
Chipotle
In a recent blog post called GREAT COMPANIES ARE FORGED DURING CRISIS we discussed why companies with economic moats, relevant products and services, and those that create stakeholder value are more resilient in the face of crisis than the average company. Less advantaged competitors, in turn, struggle, which creates opportunities for great companies to get even better.
We think Chipotle navigated the COVID environment better than any major quick-serve restaurant and has consequently gone from strength to strength. Indeed, from March 1, 2020 to March 31, 2022, Chipotle shares gained 106% versus the S&P 500 Restaurants Index’s 28% return, including dividends.
To be sure, going into 2020, Chipotle had some recent experience in managing through a crisis. Its self-inflicted foodborne illness crisis that occurred in 2015 and 2016 threatened to permanently impair Chipotle’s brand value and damage customer trust. While the company made some changes at the top, bringing in Brian Niccol as CEO, and reorganized its food preparation processes, it did not abandon its mission of providing customers with freshly-prepared, sustainably-sourced food. Even at the nadir of its crisis, the average revenue of a Chipotle restaurant remained in line with the average fast casual restaurant in the US.
When COVID arrived, Chipotle quickly made changes to its strategy. It had planned on doing a marketing push for its new Queso Blanco cheese dip in March 2020 but pivoted to free delivery to ensure its customers could get Chipotle during quarantine. Because Chipotle restaurants are all company-owned (versus most fast-food chains being franchise models), it was nimble amid panic in the restaurant industry. The company continued to build restaurants (161 new stores in 2020) and seized the opportunity to move into prime locations and add more “Chipotlane” drive-thrus.
Chipotle recently surpassed its pre-foodborne illness crisis average unit volume (AUV) levels, despite having nearly twice as many locations today. Its relevance has never been higher, boasting 26.5 million rewards members at the end of 2021 versus 19.5 million a year prior. Chipotle’s loyalty program was only launched in March 2019 and quickly became one of the most popular such programs in the US.
Management is pressing its advantage, recently upping its long-term North America store count target to “at least 7,000.” Before COVID, management dreamed of 5,000 to 5,500 locations. What changed in just two years was that the COVID period pulled forward customer preference for digital ordering and delivery, which plays well to Chipotle’s strengths. As we’ve discussed in prior communications about Chipotle, most locations have “second-line” food preparation areas where staff can prepare digital orders without disrupting flow for customers ordering in-person. Those second lines at Chipotle are so productive that if they were standalone operations, they would generate over $1 million in revenue per year, on average.
As a result of its digital success, Chipotle has rapidly increased investment in Chipotlane drive-thru locations, which have grown from 16 in June 2019 to 355 in December 2021. You cannot order at Chipotlanes in person – you need to place the order digitally and pick it up at the window. This is not only the highest-margin fulfillment type for Chipotle but is also a more efficient experience for both customer and company.
In addition to Chipotlanes bolted onto traditional store formats that include dine-in space, Chipotle recently rolled out digital-only locations without seating. These smaller, digital-only formats allow Chipotle to move into smaller markets than was previously assumed and add more locations in larger markets with less risk to cannibalization. Management discussed on the most recent call that they believe they can now go into markets with as little as 40,000 residents without sacrificing sales volume. In the coming decade, we believe Chipotle will serve and delight millions more North American customers with freshly-prepared, sustainably-sourced food at a reasonable price. And the ability to deliver on that promise at scale is ultimately what Chipotle does better than any other quick-serve restaurant. No other restaurant is even close.
Beyond North America, where Chipotle has a clear runway to more than double its current store count, we see potential for hundreds of locations in Europe. Chipotle has long held ambitions to expand in Europe but has not to date had much traction. There are currently 11 locations in London, England, five in Paris, France, and two in Frankfurt, Germany. A common denominator among these cities is they have considerable American expat communities and tourist traffic, which help support demand for Chipotle.
But for Chipotle to scale in Europe, it needs to win over customers outside major cities. We believe that European taste for Central American food is growing but is well behind where it is in North America. One metric we track is avocado demand, which tends to find itself included in Mexican recipes. According to Eurostat, Europe increased avocado imports by 53% between 2016 and 2020. While per capita avocado consumption is just a third of what it is in the United States, that type of growth suggests the gap should close. The more that European palates adjust to Central American flavorings, the better positioned Chipotle is to expand.
Encouragingly, Chipotle’s food offerings travel well in the delivery format and fast-food delivery in Europe has surged as a fulfillment method, a trend that began before COVID and has accelerated since. The more densely-populated European cities and towns allow for more efficient food delivery than in North America.
Finally, we believe Chipotle has pricing power to offset rising input costs and wages and benefits. Going into COVID, Chipotle already offered top-tier benefits relative to its peer group but pressed that advantage further in recent quarters. To address these incremental costs, Chipotle has increased prices, but the company’s scale allows it to keep prices competitive while maintaining its quality standards. In the latest earnings call, Niccol noted that CMG had raised prices by 10% in 2021 but emphasized that raising prices is “really the last thing we want to do, but we’re fortunate that we can [raise prices] and we’re seeing no resistance to date with the levels we’re currently at.” He then noted that you can still get Chipotle burritos for $8 in most parts of the country. We believe Chipotle could raise prices even more aggressively to boost near-term margins but has the ability due to its scale to lag industry price increases, which enables it to pick up market share.
Smaller, local restaurants that might compete with Chipotle on freshly-prepared, sustainably-sourced food do not have these scale benefits and we believe Chipotle’s pricing will remain relatively attractive against this set of competitors as well as national chains on a food quality-to-price basis.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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