final chipotle report

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Chipotle Mexican Grill !!!!!!!!!!

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FNCE 3363-1 Student Managed Fund

30 October 2014

Taylor Nielsen! !

Trinity University Student Managed Fund!!!!!!!!!!!!!!!!!!!!!!!!!Chipotle Mexican Grill!

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CMG Stock Price

Company Info Company Chipotle Mexican Grill Ticker CMG Exchange NYSE

Price and Market Info Current Price $641.66 52-week high $697.93 52-week low $472.41 Market Cap $20,006 Shares Out 31,013 Daily Volume 263,826

Accounting, Ratio, and Multiples Info EPS 10.47 DPS 0.00 Current Ratio 3.34 Debt/Total Assets 0.00 Profit Margin 16.76 ROA 16.92 ROE 23.52 P/E 50.2

Ticker: CMG (NYSE)

Sector: Consumer Discretionary Industry: Fast Food/Casual

Current Price: $641.66

Price Target: 406.16 Recommendation: Not Buy

Executive Summary

Chipotle Mexican Grill has been determined to

be a “Do-Not-Buy” stock. However, there are

many strong aspects of the company that force

one to analyze the risks very closely. Firstly,

this chain is the first of its kind; it sells fresh,

organic food at reasonable prices, which

people are willing to pay for even in a

recession. America’s move towards healthier

diets has helped this surge in growth towards

the Fast Casual segment of Fast Food

restaurants. Traffic in the fast casual segment

has been increasing each year, with Chipotle

leading the charge against conventional fast

food. Chipotle does not have a hard time

reaching millennials and does a great job

marketing to that demographic. Furthermore,

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Chipotle, with only just over 1700 locations and only 17 abroad, has a vast market it still has yet

to tap. The potential is all there for Chipotle as a business.

However, even though the business structure is creating a very successful company, it is not

the right time to buy this stock for two main reasons. Firstly, Chipotle has enjoyed two decades of

rapid growth unseen in this industry for years, but the decline is coming. Over the past 11 years,

Chipotle’s sales growth has decreased an average of 3.3% each year. In addition to the decline in

sales growth, the business is seeing its costs go up dramatically. The combination of increasing

costs and decreased sales growth will show us how Chipotle can manage itself in unfamiliar

waters. The second point comes from the valuation models. Chipotle is overvalued in every

valuation multiple model by at least over 50%. When compared to its industry, nearest

competitors, and when analyzing its cash flows, the company is simply too expensive. The

potential for growth makes this stock very tempting, but the price makes this stock simply too

risky.

Business Overview

Chipotle Mexican Grill is a chain of restaurants founded by Steve Ells, a graduate of the

Culinary Institute of America in NYC. The primary goal of the restaurant, founded in Denver

Colorado, was to take advantage of rising consumer demand in the Mexican cuisine market. Ells

observed the popularity of the niche in San Francisco and decided to found the first Chipotle

restaurant in 1993. Chipotle prides itself on its ability to serve high quality food at a fast-food

pace. In their mission statement, “Food with Integrity”, the company outlines their goal to provide

healthy, organic food. They also only use meat from animals that are raised cage-free and grass

fed. The chain’s attempt to supply consumers with an experience that is between fast food and

casual dining created the first Fast-Casual dining experience, the fastest growing industry sector in

the nation.


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In 1998 The McDonald’s Corporation, impressed with Chipotle’s business model, made an initial

minority investment in the chain, helping spark rapid expansion. By 2005 the company operated

over 500 restaurants around the United States. The company then introduced itself to the public in

2006 on the New York Stock

Exchange, and witnessed its

stock rise 100% on the first

day: the best U.S. based IPO

since 2000. The McDonalds

Corporation divested from

Chipotle and multiple other

investments including Boston

Market in 2006 to focus on internal matters.

Currently the chain has over 1700 locations, primarily in the United States with a few

locations in Canada, the United Kingdom, Germany, and France. Chipotle has also ventured into

other cuisine markets by opening pizza and Asian chain-restaurants with the feel and business

model as Chipotle.

The growing company has decided to refrain from paying its investors dividends. It

believes that using its return on equity on the company, rather than distributing it to investors will

benefit the company more and provide investors with more profits in the long run.

Chipotle also does not have any debt and has not held debt since 2012. However, even in

2012 the amount of debt in the company was very minimal. This gives Chipotle more freedom than

its competitors when deciding what to do with their return on equity.

International,!17,!1%!

Domestic,!1707,!99%!

Chipotle)Location)Breakdown)


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The company offers two separate food services for customers: Dine In/Carry Out and

Catering Delivery. The Dine In/Carry Out option gives the customer an opportunity to make their

own burritos, tacos, burrito bowls, and salads by selecting each ingredient at a time. While the

options are limited, the combinations customers can make are virtually endless. The catering option

brings the restaurant to the party or convention by offering dishes of each ingredient. Each guest

can make their own creation just like they do in the restaurant. Catering Sales account for about 6%

of all sales, which is up from 3.5% in 2009. Upper management has stated that this will be an area

of future growth for the company.

Due to an increase in company costs, Chipotle was forced to raise menu prices nationwide.

They completed their rollout in the end of the second quarter of 2014. So far this year, the company

has opened 132 restaurants, which is in line with their goal of 185-195 new restaurants before the

start of the New Year.

Industry Overview

Chipotle competes in one industry segment (Fast Food Restaurants) and leads another (Fast

Casual). Chipotle

essentially founded

the Fast Casual

segment when it was

founded in 1993.

The segment was

not an immediate


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hit, but over the past 20 years, it has becoming one of the fastest growing segments in the

world and is especially a hit

with millennials. Companies are springing up all over the country trying to bite their way into this

new and bourgeoning segment.

Restaurants that serve food with minimal quality, no table service, limited menus, and

meals costing under $8.00 characterize the Fast Food segment. Processed foods, which are wildly

unhealthy, are a requirement to keep costs down. Companies like Burger King World Wide

(BKW), McDonald’s Corporation (MCD), and Wendy’s Company (WEN) dominate the Fast Food

segment. Although these companies have been attempting to add healthier options onto their

menus, public view of the companies as non-healthy, cheap eateries have overshadowed their

attempts.

The Fast Casual segment offers a more fresh and satisfying experience to the fast food

industry. Some of the leading companies that make up the growing Fast Casual segment are

Chipotle (CMG), Panera Bread (PNRA), and Baja Fresh. These companies, among others, offer the

fast food experience with

higher end quality in

every facet of their

services: to the food, to

the dining experience.

Their cultivated food is

usually fully organic, the

meats come from grass


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fed and cage free animals, and trans fats are rarely used. These companies are still experimenting

with methods of offering healthy meals at reasonable costs and still keep the taste.

The dining experience is also more pleasing due to the more inviting spaces these

restaurants have designed. They have moved away from the flashy tradition in fast food restaurants

and moved closer to casual dining experience. Prices in this segment are higher due to the healthier

menu items and classier venues. Meals usually cost around $8 to $15.

The shift Americans are making to a more health conscious diet has been a catalyst for the

Fast Casual segment. Customers, even in rough economic times, are showing that they would

rather spend their money on more expensive, healthier dining options. Last year the Fast Casual

segment saw an 8% increase in guest traffic, while fast food traffic growth was relatively stagnant.

Furthermore, the leader in the Fast Food segment, McDonald’s, witnessed its traffic growth decline

by 1.3% in the past two years, while Chipotle has enjoyed 5% and 2.3% growth in the same time

span.

The three companies that will be analyzed along with Chipotle are McDonald’s, Panera

Bread, and YUM! Brands. McDonald’s will represent the big behemoths of the slowing fast food

Industry. Panera Bread will represent Chipotle’s nearest competitors in the Fast Casual segment.

YUM! Brands is the parent corporation of Taco Bell, so it will represent Chipotle’s style-of-food

competitor.


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Investment Summary

Price

%

Difference

Current $641.66 0.00%

DCF $406.10 36.71%

P/E $244.78 61.85%

NTM P/E $222.26 65.36%

P/S $360.25 43.86%

P/B $440.49 31.35%

Overview

Strong Company, but too Expensive

Chipotle Mexican Grill has a great business model

and has shown this in their sales growth over the past two

decades. However, their stock price of $641.66 leaves

little room for profit potential. Therefore, this stock is a

“Not Buy”

Possible Spending Power Decline Could Spell Trouble

Chipotle’s placement in the Fast Food/Fast Casual

industry results in a very volatile relationship to

discretionary spending. Fast food, while it is a very

convenient and cheap, it is also a luxury and unnecessary.

Furthermore, Chipotle’s higher menu prices compared to

its other Fast Food competitors means it could see a

decrease in traffic if Consumer spending power

decreases. Possible causes to the decrease in national

consumer spending are a decrease in the baby boomer

population and an overall economic slowdown following

the end of the Fed’s Quantitative Easing 3.


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Baby boomers are in their retirement years, and so they

have excess money to spend on luxury goods and

services. The decrease in this population spells a decrease

in discretionary spending.

Analysts are very skeptical of the U.S. economy’s ability

to grow alone without the Fed’s Quantitative Easing.

Economist Richard Duncan says the economy needs one

or more of three things to happen for it to grow on its

own: the workforce has to grow, salaries have to increase,

or credit has to enlarge. Right now, none of these three

requirements are occurring. Duncan said it best by

stating, “when you remove the one thing that has been

stimulating the economy and creating effective demand

by pushing up asset prices and creating a wealth effect,

then where’s the new source of growth going to come

from”? The economy has slipped back closer to recession

after each Quantitative Easing, which decreased

consuming spending. All arrows point to another

economic slowdown following the end of QE 3.


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CMG Sales Growth since 2003

2003$ 54.15%$

2004$ 49.05%$

2005$ 33.33%$

2006$ 31.05%$

2007$ 31.96%$

2008$ 22.65%$

2009$ 13.96%$

2010$ 20.95%$

2011$ 23.64%$

2012$ 20.31%$

2013$ 17.72%$

2014(Exp)$ 26.24%$

2015(Exp)$ 17.91%$

Financial Analysis

Earnings Forecast

Massive Growth Cannot Last Forever

Chipotle’s sales growth has declined an average of 3.3%

every year for the past 11 years. All projections, even

Chipotle’s, have the company’s growth rate rapidly

declining and falling to low double digits by 2017. The

hike in sales growth in 2014 was due to the national

increase in menu prices that was finally rolled out by the

summer of this year.

While Sales Growth Declines, Costs Increase

As you can see in Appendix H on page 43 and on the

figure to the left, the decrease in sales growth and

increase in costs as a percent of sales plan to hit chipotle

with declining revenues. The most notable cost hikes are

increases in beef, avocado, and dairy products. Food,

Beverage, and Packaging Costs already make up over 1/3

of sales. Other cost increases due to effect Chipotle’s

strong growth are Occupancy Costs, Marketing Costs,

and Capital Expenditure Costs, which are projected to

increase from $200 million to $235 million this year.


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Net Income

2013 2014(E) 2015(E)

$327.44 $387.58 $378.54

All figure in Millions

Food & Labor Costs

2014(E) 2015(E)

Sales $4,058.10 $4,784.90

Food $1,400.04 $1,650.79

Labor $913.07 $1,196.23

All figures in Millions

Government Could Increase Labor Costs Even More

President Obama, in his 2014 State of the Union speech,

pressured congress to increase the national minimum

wage to $7.25/hour to $10.10/hour. While Chipotle’s

average worker earns about $9, the increase could create a

ripple effect for a company with over 45,000 employees.

With the increase in food and administrative costs already

affecting the company, this could exacerbate things even

quicker. Furthermore, Chipotle states in their 2013 10K

Report that the Affordable Care Act could affect their

costs. They state that, “employer mandate and employer

penalties are expected to become effective in 2015 may

dramatically increase labor costs.”

Ratio Analysis

Decline in Comparable Restaurant Sales

Comparable Restaurant Sales are the change in sales for

restaurants that have been in business for over 12 months.

After three quarters of 2014, which have resulted in

19.8% increase in comparable restaurant sales, Chipotle’s

executives stated that they expect, “low to mid-single

digit comparable restaurant sales increases” for 2015.


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Return on Equity

Industry Chipotle

2011 40.11 23.17

2012 41.23 24.28

2013 33.88 23.52

3 Yr Avg 38.40 23.66

5 Yr Avg 46.42 22.75

This announcement in mid-October of 2014 forced the

stock to drop

Low ROE for the Industry

As you can see in Appendix E, Chipotle has the lowest

Return on Equity in the analysis performed on its three

representative competitors (MCD, PNRA, & YUM).

ROE, since the company does not pay dividends, should

be used to spark more growth. With competitors having

more return on their equity, Chipotle

Valuation

Relative Valuation Multiples

Chipotle has a stock price that is over 45 times its earnings value. Its nearest competitor is Panera

Bread with a P/E of 24.50. Even with a growing and fairly stable company, a price that high is not

justifiable to buy at this time. By referring to Appendix I, it is clear that Chipotle’s stock price in

relation to earnings has grown considerably in the past ten years. This may indicate a stock that

was worth a buy a few years in the past, but is not worth it now. Furthermore, analyzing Chipotle’s

other multiples (NTM P/E, P/S, P/B, & EV/EBITDA) it is apparent that this stock is overvalued in

relation to its competitors.


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Chipotle vs. Panera Bread

It is worth looking at the relation of multiples between Panera Bread and Chipotle since they are

both in the Fast Casual segment and are therefore very similar. However, even after comparing

their multiples, Chipotle is still clearly overvalued.

CMG PNRA

%

Over/Under

P/E $641.44 $314.34 50.99%

NTM P/E $641.44 $301.51 52.99%

! ! ! !P/B $641.44 $396.89 38.13%

Why is Chipotle so Expensive?

Investors obviously believe this to be the fair value for Chipotle, but why? If all other firms in their

industry are massively cheaper, then what makes Chipotle seem different? Chipotle has a lot of

potential. It has massive markets that it hasn’t tapped yet, and it’s the front-runner in a booming

segment. It could possibly break $700 by 2016. However, with its slowing growth and expensive

price, I do not see this potential being worth the risk.

Discounted Cash Flows Valuation

As you can see in Appendix F, Chipotle’s Free Cash Flow to the Firm will be $455 million and

$398 million in 2014 and 2015, respectively. With these calculations and the assumptions of a 15%

super growth rate for 10 years and a steady growth rate of 5%, it was determined by the use of the

H-Model in Appendix H that the company’s total Discounted Cash Flow is worth $12,597,322.44.


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When divided by Chipotle’s shares outstanding (31,013) we get the correct valuation for Chipotle’s

stock of $406.19. This valued price means Chipotle’s current price of $641.66 is 46.7% overpriced.

Sensitivity Analysis

It was calculated by the risk premium approach that the firm’s Cost of Equity is 9.354%. Although

the calculation is high, it is also a very conservative number. The calculation was done by

examining firm with similar structures and averaging their costs of equities.

This sensitivity analysis provides the ability to see what could happen with this stock in the best

and worst case scenarios. For Chipotle’s current stock price to be profitable, the firm would need to

cut its costs of equity by two full basis points.

!! Super!Growth!Rate!Assumption!

Cost!of!E

quity

!Assum

ption!

406.10! 10.84%! 12.75%! 15.00%! 17.25%! 19.84%!

11.32%! 243.43! 259.10! 277.53! 295.97! 317.17!

10.29%! 291.45! 310.51! 332.95! 355.38! 381.18!

9.35%! 354.81! 378.38! 406.10! 433.82! 465.70!

8.42%! 452.89! 483.42! 519.34! 555.26! 596.56!

7.58%! 602.07! 643.21! 691.62! 740.02! 795.68!


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Bibliography

FactSet

IBIS World

Value Line

Chipotle Q3 Earnings Report

Chipotle 2013 10k Report

http://www.trefis.com/stock/cmg/model/trefis?freeAccessToken=PROVIDER_f87fcb465dddb3117796fc9a36e48614d7b52ef3 http://www.forbes.com/sites/greatspeculations/2014/06/23/how-the-fast-casual-segment-is-gaining-market-share-in-the-restaurant-industry/ http://finance.yahoo.com/news/chipotle-starbucks-enter-minimum-wage-110806756.html http://www.financialsense.com/contributors/cris-sheridan/trillion-dollar-question-qe-ends http://millennialmarketing.com/2014/06/casual-dining-with-millennials-tips-from-qsr-and-fast-casual-brands/ http://www.huffingtonpost.com/burgerbusiness/fast-casual-thrives-fast_b_4731097.html http://www.usatoday.com/story/money/business/2014/10/20/chipotle-fast-casual-restaurants-earnings/17626289/


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Appendices

Appendix A


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Appendix B Income Statement


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Balance Sheet


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Cash Flows


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Ratios


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Appendix C McDonalds Income Statement


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Balance Sheet


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Cash Flows


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Ratios


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Panera Bread Income Statement


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Cash Flows


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Ratios


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Appendix D Data & Correlations – Industry


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Soft Factors – Industry


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Firm Sales Forecast


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Soft Factors – Firm

Chipotle makes up a relatively small portion of the fast food industry. However, Chipotle has been revolutionizing fast food industry by start the fast casual industry. Of which, it makes up a significant part

Although Chipotle's Sales are very sporadic, they have always been positive. In fact, in the last 5 years Chipotle has averaged a 19.3% sales growth

Chipotle has very limited items on their menu, but the ways in which people can mix the items are "unlimited". McDonalds and YUM! Brand companies have larger menus, but they are very strict and cannot be changed much. Chipotle is known for using fresh ingredients and only using meats from grass fed animals.

Chipotle has recently offered Tofu for their vegetarian customers and have also opened pizza and Asian cuisine franchises based off their original service model. Chipotle is currently developing and testing more menu items to satisfy customer demand Many upper level managers of Chipotle, including the founder and CEO, travel periodically around the US to personally let employees ask questions and to give advice to their regional managers Customers are encouraged to call upper management personally so they can find the roots of the problems customers are having Chipotle does not market as much as their competitors, but their marketing is effective when they choose to do it. They have only had 1 mainstream commercial, which was instantly a hit.

The new-age healthy generation loves the way chipotle has branded itself. They believe chipotle is the start of a revolution of healthy fast food eating in the US


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Appendix E


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Appendix F Income Statement


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Balance Sheet


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Cash Flows


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Free Cash Flow


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Appendix G


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Appendix H


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Appendix I

final chipotle report

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