Chipotle Action (CMG): is it a good buy?

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Chipotle Mexican Grill started out as a simple burrito store in a converted ice cream parlor in Denver in 1993. Founder Steve Ells envisioned the restaurant as a cash cow that would fund a more expensive, riskier fine-dining establishment. But over the years, plans to move upmarket were scrapped as Chipotle grew into a huge chain of 3,000 stores.

The restaurant has attracted a young and loyal fan base with its industrial chic decor and has used fresh ingredients that give a healthy twist to traditionally low-end Mexican cuisine. Unlike its competitors at large fast food chains, Chipotle was also known for its commitment to investing in its people, sourcing ingredients locally, and respecting environmental sustainability.

To avoid obscuring the limited menu, Chipotle has launched several new items in recent years, including artisanal quesadillas, carne asada, super green salad, and plant-based chorizo.

The direct ownership model

Unlike other national chains, Chipotle does not franchise its concept. As new outlets opened at the rate of several hundred each year, Ells and his partners chose to retain direct ownership of the entire chain.

The stated goal was to gain better control over the appearance and quality of food, but direct ownership has also benefited the company’s finances. Instead of royalties being paid by third-party operators, Chipotle earns its money directly from in-store sales and digital restaurants, as well as price increases charged for items delivered.

For this channel, direct ownership worked. As major franchisors Subway, McDonald’s and Domino’s looked on enviously, Chipotle’s sales have grown steadily over the years, reaching a record high of just under $ 6 billion in 2020.

The stock also shot skyward. While the company kept the free float, that is, the available stocks relatively small, the rapid gains in net income pushed the price of Chipotle shares to a record high of $ 1,958.55 in 2021.

Increase in digital sales

Along with other fast take out / drive-through restaurants, Chipotle had advantages while dealing with the COVID-19 pandemic. The company has also benefited from its investment in digital control, which enables delivery as well as pick-up from customers via dedicated “Chipotlanes”.

Booming online and mobile platform sales jumped from 10.9% of revenue in 2019 to 46.2% in the pandemic year of 2020, when dining out was restricted – or in many places , completely closed.

Innovation in the customer experience didn’t stop with digital control. Chipotle Extras, an enhanced loyalty program, had attracted 24 million members by September 2021. As explained in a press release from the company, each member has an individualized profile on the Extras app, which “plays Chipotle Rewards with Custom challenges to earn extra points and collect achievement badges.

Expansion continues unhindered

At the start of the COVID-19 pandemic – as the restaurant industry grappled with declining traffic, employee retention and logistical challenges – Chipotle skillfully navigated troubled waters, opening several hundred new stores . As the pandemic eases and customers return to in-store restaurants, the chain is planning further expansion in Europe, with an ultimate target of 6,000 outlets internationally.

The company is poised to leverage its digital footprint as it expands across the UK and across Europe. Commenting in mid-2021 on the outlook for quick and casual Mexican stores in this market, new CEO Brian Niccol told Restaurant Business that Chipotle has “more leverage than ever to succeed in new markets, between our digital system, the he variable advantage of the designs we can bring to the market and… just the strength of the brand.

Food safety concerns grab headlines, fines

Chipotle has had its share of negative headlines regarding food safety and employee retention. A fast-paced, laid-back restaurant that emphasizes local, ready-to-use, and always fresh ingredients puts a lot of stress on line cooks as well as suppliers. The shortcuts and careless preparation of food caused outbreaks of foodborne illness on several occasions before the pandemic.

In April 2020, Chipotle accepted a fine of $ 25 million, a record amount in a food safety settlement, on felony charges of breaking the food, drug and cosmetic law.

Gains don’t slow down

The regulation and headlines didn’t seem to dampen customer appetites in 2021, when restrictions related to the COVID-19 pandemic eased and Chipotle continued to report record profits.

For the second quarter of 2021, the company reported net earnings of $ 6.60 per share and exceeded expectations for net earnings and sales. This is a solid gain from the $ 0.29 recorded in the second quarter of 2020, depressed by COVID-19. Comparable store sales increased 31%, while operating margins also improved.

In recent quarters, Chipotle has made a habit of beating analysts’ earnings forecasts. The market rewarded the company with a very rich price-to-earnings ratio of around 63, higher than that of forward-thinking competitors such as Starbucks and Texas Roadhouse.

As reported in CNN Business, analysts are positive on the stock’s outlook, with a median 12-month target of $ 1,981. But there is an extremely wide range in the expected stock price, with the highest estimate reaching $ 2,600 and the lowest at $ 1,256.

Future prospects

While Chipotle has arguably been the country’s most successful restaurant chain in recent years, it also enjoys a very rich stock price. The price-to-earnings ratio is historically high-end and in October 2021 was triple that of the P / E of the S&P 500 (already particularly high at around 30). Confident individual investors, institutions and hedge funds may start to falter if there is bad news or declining profits in the future.

There is no shortage of possible causes.

  • Staff issues. Like all restaurants, Chipotle faces a post-pandemic labor shortage.
  • High and rising labor costs. In 2021, the company adopted a minimum of $ 15 an hour and increased menu prices by 4%. It also intends to maintain a long-standing policy of providing good health and education benefits to the 90,000 workers it directly employs.
  • Inflation. While predicting a stock price above $ 2,100 ahead of the October earnings release, Goldman Sachs analysts also voiced the flip side of consensus earnings and earnings forecasts.

Goldman pointed out that Chipotle’s practice of sourcing ingredients locally made it particularly vulnerable to price inflation: “Gross margins could come under pressure from commodity inflation, especially if purchases of Spot proteins are needed to keep up with high demand. The big investment bank also predicted that labor costs would only increase.

Ultimately, however, Goldman and others were in the third quarter. On October 21, Chipotle announced a significant drop in sales and net profit forecasts. Profits reached $ 7.02 per share, while revenues of $ 1.95 billion exceeded the consensus estimate of $ 1.94 billion.

Analysts were right about the higher costs, but Chipotle was able to weather its rising expenses with its menu price hike. This was no problem for same-store sales, which rose 15.1%, and digital sales, which beat the previous quarter by 8.6%.

Chipotle Action: is it a good buy?

Owning stock in this company means betting that its rapid growth can continue and that the stock can maintain a high P / E multiple. Investors also need to be confident that Chipotle’s direct-owned business model can accommodate double the number of stores and avoid stumbling blocks while expanding into overseas markets.

Analysts remained positive on the title. Of the 33 analysts recently polled by the Wall Street Journal, 18 rated it as a buy and 12 as a hold. More positive news on the earnings front should provide support, but beware of market turbulence, which can hit high-end growth stocks harder than they affect more stable ‘value’ games. in the stock market universe.

Good to know

Investors may be hesitant when considering buying among high-end growth stocks such as Chipotle. A rich stock price and high P / E ratio means there is a long way to the bottom if the company stumbles. But the hip, laid-back Mexican restaurant has found success with good management and trendy concepts, and Chipotle has demonstrated strong sales and profit growth even in the face of food safety issues and a pandemic.

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About the Author

Writer and editor with over 100 book credits in the non-fiction format for youth and young adults, Tom Streissguth has mastered the art of clearly explaining complex and difficult topics. His books have covered history, geography, economics, media and current affairs; he also wrote biographies of historical figures for Lerner, Enslow, Facts on File, Greenhaven and other major educational publishers.

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