CMG stock pitch
march 17, 2007
Chipotle Mexican Grill (CMG)
industry overview
Restaurants are generally divided into four different categories: casual dining, family dining/buffet,
quick service, and specialty, which each have different analyses. Restaurants can be staple stocks, such
as McDonald’s (MCD) which offers steady growth and returns, or high-growth stocks, such as Panera
Bread (PNRA), which is experiencing high growth as it penetrates the market. As new types of
restaurants become popular each year, the high-growth stocks turnover rapidly with the changing
trends.
Major Factors/Drivers
 Revenue growth
 Same store sales
 Commodity prices, specifically beef prices
 Demographics
 Consumer desires
 Overall economy
In 2005, the restaurant industry struggled with companies underperforming the market due to the
reporting of dismal sales and EPS by many restaurants for 1H05. May sales were solid, while April and
June sales suffered greatly, resulting in lower than expected earnings. The economy in 2005 was also
difficult for restaurants as energy, interest rates, and beef prices were all an issue for restaurants. As
some relief is coming in these areas, it will likely benefit the industry. EPS reaccelerated in the
remainder of 2005 and growth rates were in the mid-teens for 2006.
To counteract the impact of higher beef, poultry and dairy prices, most restaurants increased prices
substantially in the first half of 2005 with little effect on customer traffic. In the restaurant industry, the
casual dining segment remains a bright spot. Older, more affluent customers are increasingly choosing
full-service restaurants over fast food chains. With consumers spending more of their discretionary
income on dining out, we expect the trend toward more upscale menus to continue. However, higher
gas prices could result in a near-term dip in this trend. We expect same-store sales growth and earnings
gains at restaurants to moderate over the next two years. The casual dining segment has been the fastest
growing segment of the restaurant industry over the past few years. This type of restaurant offers an
attractive dining experience coupled with rapid delivery of standardized menu items. This segment of
the industry still has significant expansion potential as it accounts for just 2.4% of industry revenue.
(The U.S. restaurant industry generated an estimated $476 billion in sales in 2005, or about 4% of
GDP.)
business overview
Chipotle Mexican Grill opened its first store in 1993 and became a subsidiary of McDonald's in 1998.
The company operates in the casual dining segment of the restaurant segment and has seen substantial
growth over the past 10 years. The company currently operates some 490 stores that offer quick service
but maintain classic cooking methods and utilize high-quality ingredients. The company has a tightly
focused menu but store design and decor vary by location. The company has been expanding rapidly in
recent years as demand for southwestern menu items has spread throughout the United States. An
emphasis on cultural cuisine has been rampant in the industry, as seen by P.F. Chang’s and similar
concepts, and Chipotle has further capitalized on this trend.
Chipotle’s CEO, Steve Ells, has been with the company since inception and has guided it through the
rapid growth phase. Attending University of Colorado and the Culinary Institute of America, Ells
combines his down-home nature with a savvy for the industry and love of natural ingredients and food.
competition
Company
Cheesecake Factory Inc
Starbucks Corp
P.F. Chang's China Bistro Inc
Brinker International Inc
Chipotle Mexican Grill Inc
Wendy's International Inc
Outback Steakhouse Inc
Yum! Brands Inc
Darden Restaurants Inc
McDonald's Corp
EPS Growth %
20.0
19.7
18.9
18.6
18.5
15.4
11.7
10.6
10.3
9.6
P/E
24.8
41.1
27.7
16.3
38.0
22.4
19.3
15.7
17.4
14.4
financials
Chipotle Mexican Grill opened more than 180 stores in 2005, and intends to continue to open new
locations at an aggressive pace over the next few years. The company has benefited from the increasing
popularity and acceptance of Mexican food within mainstream American culture, a trend that should
continue over the next decade. Chipotle Mexican Grill has seen operating costs rise rapidly over the
past few years but has been able to grow revenue at an even faster pace, thus holding costs as a
percentage of revenue in check and even managing to improve margins over the past year. The
company generated $470.7 million of sales in 2004 and we believe that sales rose more than 29%, to
over $610 million, in 2005. While the company's revenue growth rate is likely to slow as it gains scale,
we expect sales to expand at a nearly 20% annual rate through the end of the decade. The company will
face higher costs as a result of its new public company status. It will also face rising administrative costs
as it becomes more independent of McDonalds. It is likely that McDonald's will distribute its shares of
CMG to McDonald's shareholders within the next three years.
The company has no long-term debt and nearly $100 million in cash and equivalents following its IPO.
The company has total long-term obligations of $724.1 million (from leases) and a very healthy current
ratio of 3.8 based on the most recent available numbers. However, company operating margin was just
1.3% in its latest reported full year (2004). Even after considering the rise in operating margins to just
over 5% in the first nine months of 2005, this is still only about half the average operating margin for
the company's peers. The low operating margin, along with our outlook for higher operating costs,
does pose some concern. The company does not pay a dividend on the common stock at this time. We
do not expect one to be instituted within the next year as the company will retain cash to fund its
expansion.
A more in depth analysis of each of the financial statements would be appropriate here, but in an effort
to save paper, I have omitted the full analysis.
valuation
At recent prices, CMG shares appear overvalued on a near-term basis. The shares have a current-year
projected P/E of 54.5 compared to a peer average of 26. The CMG shares have a price/book ratio of
3.8, compared to a peer average of 3.5. On a price/sales basis, the shares would have a multiple of 2.5
using a revenue per share and a multiple of 3.2 using the 2004 sales number. These multiples are well
above the current peer average of 1.6 using the latest full-year reported sales. The company's margins
are also below average, at about half the 9.9% average among the company's closest peers. However,
balancing this is CMG's sales growth rate, which is among the highest in the industry (49.2% in 2004
and an estimated 29% in 2005). CMG shares offer the opportunity to invest in the rapidly expanding
casual dining segment - with an ethnic cuisine that is itself experiencing rapid growth. With a clean
balance sheet, outsized growth and significant expansion potential, investors have viewed the CMG
shares very favorably in relation to peers, despite the prospect of higher operating costs that will mute
margin expansion over the next few years.
investment opportunities
CMG is well positioned in the casual dining segment to take advantage of the substantial projected
growth. With an aging American population which prefers casual dining restaurants, we expect that the
strength of the segment will continue going forward. Moreover, CMG has already demonstrated
substantial growth within the sector and flourished while under the management of MCD. With an
emphasis on all-natural and organic products, and a movement in that way, we believe that CMG will
further capitalize on the growing health trends in the United States.
Moreover, the financial metrics of the company and each story are well suited to provide the company
with the financial ability to succeed with the high growth it has established. Lastly, positive investor
sentiment as seen by the IPO is further reason to support our hypothesis on the stock.
investment risks
The operations of CMG are subject to shifts in the general economy and in popular eating habits. The
company will also continue to face significant execution risk from its rapid expansion and it could
experience margin contraction if it is unable to replace the services currently provided by McDonald's
at a comparable cost. In addition, the company operates in one of the most highly competitive
segments of the already competitive restaurant industry. Operations could also be affected by outbreaks
of disease or public perceptions of disease risk. Finally, the company could experience disruptions
and/or higher costs if necessary ingredients become unavailable in some areas. With a market
capitalization near $1.5 billion, CMG is classified as a small cap growth issue.
investment recommendation
The shares appear overvalued at recent market prices near $43, though we view the company's market
positioning and prospects for growth as outstanding. In the near term, CMG will need to expand
margins while absorbing additional operating costs as it completes its separation from McDonald's and
faces the costs of being a public company for the first time. In addition, management will have to
manage the company's rapid growth to near perfection in order to satisfy the investor expectations that
now appear to be built into the stock price. Based on current company fundamentals, we would expect
the shares to trade between $35 and $45, and building in a significant growth premium, we would view
the shares as appropriately valued on a near-term basis between $31 and $38. The shares are currently
trading well above even this adjusted range.
Following the company's IPO in January at a share price of $22 (up from an earlier projected price of
$18), investors snapped up the shares, allowing CMG to rack up a first day gain of 100%. The shares
then rose above $49 by the end of January, before retreating to the mid-$40s. In the company's IPO on
January 26, 2006, the selling stockholder granted the underwriters an overallotment option because of
the high demand for the stock. The company used the proceeds from the offering to repay the
outstanding balance under a $30 million revolving credit line it has with McDonald's. The remainder is
to be used as capital for expansion. Following the offering, McDonald's Ventures owned 65% of the
common stock and controlled 87% of the voting power of CMG.
Despite the current valuation of the stock, we believe that CMG will excel in the coming years in
response to the growing casual dining segment and an emphasis on natural eating. We rate the stock as
a BUY at market price and recommend that Smart Woman Securities invest in the entity.
full financial statements
You should typically include full financial statements here, including the income statement, balance
sheet, and statement of cash flows. In an effort to save paper, I have omitted these pages.