This Spicy Little Stock’s Got A Recipe For Growth

You’ve probably stood in line waiting for a burrito, trying to figure out how many customers Chipotle’s well-trained team can usher through in an hour, what the actual costs are for the ingredients wrapped into your tasty lunch, and how much employees earn. A bit of mental arithmetic and you’ve figured out the firm’s profit margins. You might even have wondered how much you’d need to shell out to open a restaurant. Depending on your math, you might’ve asked yourself whether it’s possible to get your hands on a franchise agreement and become a restaurateur. No? Just me then…

Anyway, the bad news is you can’t become a Chipotle franchisee, even if you wanted to. Their restaurants are just too profitable to let anyone else into the fold, so the firm owns them all. The good news is that those calculations are vital to understanding Chipotle’s business model if you want to become a different type of owner: a shareholder.

So let’s dive in and see what the Chipotle investment case is.

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Here are the investment TLDRs.

1. Chipotle restaurants are cash machines, and the profit they churn out covers initial build costs in under three years. After that, each restaurant’s profit fuels Chipotle's new-restaurant growth engine.

2. Opening the doors on new restaurants could unlock sales growth of 8% to 10% a year for at least ten years.

3. Chipotle’s a forward-thinker, exploring artificial intelligence (AI) along with other technologies to boost restaurant performance and keep Chipotle’s flywheel spinning.

I’ll take you through all three, tell you what the risks are, and then wrap it all up at the end here, like a big, amazing burrito.

1. Chipotle makes money (and burrito bowls).

The best way to analyze Chipotle (or any bricks-and-mortar, consumer-facing firm, for that matter) is to imagine it as a single restaurant, figure out its profitability, and compare that to its startup costs to see what return (profit) each restaurant can deliver on an investment (initial outlay). This is known as unit, or “four-wall”, economics analysis. If the unit economics stack up, it's then a matter of mapping out how many restaurants Chipotle might conceivably open before it hits a saturation point and sees its growth dry up.

To conduct that single-store analysis, you need to know a few things. First, the revenue of an average mature Chipotle restaurant. That’s easy enough, just take the firm's total revenue and divide it by the number of restaurants. Next up, each store’s running costs. Chipotle details costs such as labor and rent as a percent of sales in its financial statements, so those percentages can be applied to a single shop. Finally, you’ll need the initial cost to build a restaurant: luckily, Chipotle management doesn’t hide that stat either.

I’ve laid out an analysis (including revenues, costs, profit, and build costs) for a single new Chipotle restaurant in the spreadsheet below.

Unit economics for a typical Chipotle restaurant. Source: Chipotle financial statements.

Each new outlet takes a few years to get into full swing, which means that it won't hit the company average sales of $2.8 million until year three. On top of that, some running costs – like occupancy (rent) and labor (wages) – are relatively fixed no matter how busy the restaurant is, and so these expenses are a higher percentage of revenue in the early years too. That means the younger Chipotle restaurants that haven’t hit their stride are less profitable than older ones. Still, even a fledgling one-year-old restaurant slaps 19% of its sales onto the profit line. That climbs to 21% in year two, and matches the company average of 24% by year three.

And it’s not as if these restaurants stand still after three years either. See, as Chipotle’s popularity’s grown, the firm’s managed to post consistent comparable sales growth (literally, sales from individual restaurants, compared to how they did the year before). What’s more, some of the costs to run a restaurant are relatively fixed (think: rent) which means that as sales grow, profitability should grow faster.

Perhaps most striking about Chipotle’s restaurant economics, though, is that the initial outlay to get up and running is only around $1.1 million. And what that means is that each store delivers a huge return on that initial investment, and recoups all of it in just over two years.

So, let’s hop back into the Chipotle lunch line armed with this knowledge. Imagine you could cobble together $200,000 (not easy, but not impossible either) borrow another $900,000 from the bank, and open your first Chipotle restaurant. Assuming you can replicate the average store’s performance, you’ll have repaid that loan in under two years and be clearing nearly $700,000 (and growing) in profit after that. Restaurants do need a facelift from time to time, but that won’t break the bank, so open as many Chipotles as possible and you’ll be fast on your way to becoming a burrito billionaire.

It’s no wonder, then, that Chipotle keeps hungry would-be franchisees locked behind the company’s gates: it wants all that profit for itself (or rather for its shareholders).

With such encouraging per-store profit, the next logical question, then, is how many can they open?

2. It’s cooking up plans for more stores (and more sales).

Chipotle’s revenue growth has motored along at an average of 11% for the past ten years with new stores accounting for around half of that growth (comps being the other half). Recently, the firm announced it’s stepping up the pace of new openings, and last year it cut ribbons on 236 new outlets – taking the total to just over 3,000. Now, management believes that there’s space for 7,000 restaurants in the US, and it plans to expand its footprint by 8% to 10% a year. If they’re right, Chipotle should chalk up at least 8% sales growth for the next decade and more. That assumes comps don’t start to decline, of course, but Chipotle has a few tricks up its sleeve to make sure that doesn’t happen (more on that later).

That 7,000 target isn’t guaranteed, of course. It assumes Chipotle can keep competition at bay and that Americans don’t tire of the Mexican grill concept. But take a look at the chart below: it shows the restaurant count for America’s biggest fast-food companies. Compared to those other chains, 7,000 Chipotles seems reasonable enough.

Source: Company accounts.

And that’s just the US. International growth is a whole different bowl of guacamole. So far, Chipotle’s overseas expansion has been very measured. And that strategy shows management has owl-like wisdom. See, historically US firms have made the mistake of rushing to export a successful US formula to foreign shores, only to find they haven’t thought it through properly. Retailers from Abercrombie & Fitch to T.J. Maxx (which botched its first European expansion) learned this lesson the hard way. And when it comes to restaurants, while America (at least outside of big cities) is dominated by chains, international markets tend to be way more fragmented and competitive. So, near-term sales growth might not get a massive boost from international store openings, but over the longer term, there could be at least as many restaurants around the world as there are in the US.

So you’ve got a healthy pace of opening highly cash-generative restaurants. Now to those nifty tricks management’s got up its sleeve to pump out even more profit from existing shops...

3. It’s working toward a futuristic, human-free lunch.

When it comes to technology, Chipotle’s an innovator among restaurateurs. The firm hired its first chief information officer (now its chief technology officer) back in 2015 when, he recently told a reporter, the only technology used for online ordering was, incredibly, a fax machine. Now, that might be only eight years ago, but that feels like generations ago when you look at today’s fast-food experience. Covid-induced lockdowns forced every restaurant chain to scramble for digital and delivery capacity, but because Chipotle was ahead of the game, it was able to lean into that digital tailwind, which whipped up to hurricane strength overnight. That’s why Chipotle managed to grow sales by 8% in 2020, even as most of the country sheltered in place. And in 2022, 200 of the 236 new restaurants Chipotle opened were Chipotlanes: the firm’s fully digitized format with drive-up pickup lanes. It meant that nearly 40% of the firm's 2022 revenue came from digital orders.

Today Chipotle has two big ambitions when it comes to technology. The first is to work with its cloud provider Microsoft, and tap into its artificial intelligence (AI) and machine learning services to develop fully automated (i.e. no human intervention) order-taking and processing. The second is to roll out advanced robotic meal preparation equipment across its restaurants. Last year, Chipotle launched its very own venture capital fund (Cultivate Next) which took a stake in Hyphen, developer of the Makeline Kitchen Robotics equipment, and the two firms have started work on digitally enabled, automated order preparation.

A Chipotle automated prep machine, able to produce your burrito without human assistance.

In the future, then, your app order might be received, processed, and ready for collection without any human intervention whatsoever. Send out an Amazon drone to collect and deliver it, and it’d almost be a shame for a human to enjoy the fruits of those robotic labors. (Almost.)

Both these initiatives are aimed at squeezing more out of each existing restaurant by boosting sales growth without incurring added costs. If successful, technology could help Chipotle spin its flywheel faster still.

Here’s the stuff that could go wrong.

Firstly, the restaurants mightn’t be able to continue performing at elevated levels. Two things could go wrong: sales (the comp type) might start to dip, and upward pressure on costs could attack margins. Over time, the margin risk should be manageable as Chipotle fully utilizes its technology investments. But near- and long-term comps can always come under pressure because of macroeconomic factors, increased competition, or both.

Secondly, there’s the size of Chipotle’s total potential market. Management believes that the US can support 7,000 restaurants. But that assumes that the Mexican grill concept stays popular, and a tastier and potentially cheaper competitor doesn’t come along and eat Chipotle's lunch.

Both risks are meaningful in isolation, but they overlap too, with “competitive threat” being the common denominator. See, increased competition would hurt sales and profitability of individual stores and hinder Chipotle’s long-term growth plans. And that’s important because if existing stores start flagging, and the firm misses its opening target, the whole flywheel thing gets thrown into reverse. And that can quickly become destructive for the business and its shareholders.

I’d also be remiss not to mention Chipotle’s food contamination past. In 2020 the company paid a $25 million fine to resolve criminal charges relating to an outbreak of food poisoning a few years earlier. The outbreak shook the firm to its core and triggered a root and branch review of its supply chain and food safety standards. Chipotle has put the issue behind it, and you’d hope lightning won’t strike twice. But with restaurant chains, food poisoning is always a risk. Chipotle isn’t the only major restaurant chain that’s suffered from such things, after all.

Then there’s valuation: at 36x price-to-earnings (P/E), Chipotle’s shares aren’t exactly given away. But traditional valuation multiples like price-to-earnings P/E aren’t very useful for valuing businesses that expect to generate most of their profit in the future. Instead, I use a rough discounted cash flow analysis to find out what growth rates the market’s baking into the share price. The punchline is that the market seems to be pricing in 14% growth in cash flow for the next ten years and 3% after that.

And that’s perfectly doable, with our assumptions that Chipotle will grow its store count by at least 8% a year for more than ten years, that innovation and technology help comp sales tick along, and that margins will continue to expand. So, the share price certainly appears expensive using multiples like P/E, but expensive doesn’t necessarily mean poor value.

Discounted Cash Flow (DCF) analysis. Source: Koyfin.

And here’s your Chipotle, um, wrap.

Over the past ten years, Chipotle’s grown its free cash flow per share by an average of 12%, and its share price has more than matched that, returning 17% a year. That’s a tough pace to beat and investors probably shouldn’t expect a repeat over the next decade. And there are competitive risks (there always are) that could derail Chipotle's growth story too.

But there’s a lot to like about Chipotle. Near 10% sales growth from new stores alone is attractive, and assuming management doesn’t take its eye off the ball, there’s a decent chance that each of those new stores can produce the profit to fuel yet more growth.

So if you’re a growth investor, attracted to a clear plan for long-term sales growth, and believe that Chipotle can protect and repeat each new store's performance metrics, then being a shareholder mightn’t be a bad consolation prize for not being able to own your own Chipotle Mexican Grill.