Chipotle's Strong Value Proposition Underpins a Durable Long-Term Growth Narrative

Senior Equity Analyst

Sean Dunlop

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Chipotle's business strategy rests on five pillars: running successful restaurants; attracting and retaining diverse talent; making the brand visible, relevant, and loved; investing heavily in restaurant tech and innovation; and improving access and convenience for customers. In our view, the company has carved out an enduring niche in the U.S. restaurant landscape, with competitive menu prices, extreme convenience, and "food with integrity" allowing the firm to lure away customers from both casual dining and traditional fast-food competitors.

Chipotle's digital investments have seen the firm build a loyalty program 38 million members deep in just five years, with online sales of $1.1 million per store in 2023 outpacing total unit sales at many name-brand competitors. We view a strong loyalty program as accretive to customer lifetime value and the brand's value proposition, driving increased order frequency, reducing customer churn, and helping the firm drive menu development and marketing strategies based on relevant-time customer data. While we expect many technology features to become table stakes in the industry moving forward, we appreciate Chipotle's attention to unmediated access to its customers, building a compelling database of order history, price elasticity, and new product resonance. 

The burrito chain's unit development narrative remains compelling, with strong returns on investment driving our high-single-digit annual unit growth estimates. New-format stores (Chipotlanes, digital-only concepts) offer attractive upside, yielding access to heretofore inaccessible trade areas like office buildings, college campuses, and freestanding suburban concepts, leaving us encouraged as Chipotle links the optimal store footprint with its corresponding trade area.

Ultimately, we view management's strategy as appropriate, with Chipotle well positioned to meet future customer demands (elevated off-premises mix, blurring lines between fulfillment channels, faster service, increased importance of health and sustainable sourcing), and appearing to boast sufficient pricing power to defray persistent inflationary pressure.

Business Strategy & Outlook

The restaurant industry is intensely competitive, with nonexistent switching costs and constantly evolving customer demands rendering it difficult for operators to carve out durable competitive advantages. Firms able to do so, in our view, generally benefit from some combination of pricing power attributable to an enduring brand intangible asset, strong relationships with master franchise partners and an internationally replicable concept, compelling store-level economics, or scale-driven cost advantages. In our view, Chipotle merits a wide economic moat, with industry-leading comparable sales growth, a loyal customer base, and advantaged positioning to meet changing consumer demands likely to catalyze excess returns through the 20-year horizon implied by our wide-moat rating. Our adjusted ROIC forecast embodies this view, with average ROICs of 37% during our explicit forecast healthily outpacing the firm’s 9% cost of capital.

Following the firm’s food safety scares in 2015-18, we maintained a narrow moat rating for the firm, with the view that the Mexican chain may have permanently impaired its brand intangible asset (based on its “food with integrity” mantra), which we anticipated would materialize through slower comparable sales growth and elevated marketing expenses as the firm “bought” traffic with free and discounted food. We viewed increased costs attributable to onerous food safety requirements, legal scrutiny, and outperformance by fast-casual competitors as likely to stymie growth, while maintained absence of the firm’s loyal customers due to restaurant closures could have instigated a migration toward competing health-oriented fast-casual concept. In retrospect, some of our concerns were valid—average store sales dropped nearly 20% from $2.4 million before the crisis to a bottom of $1.9 million in the fourth quarter of 2016 before slowly recovering to $2.5 million in 2021—but strong unit growth and comparable store sales performance between 2017 and 2020 drove double-digit systemwide sales growth, allowing the firm to quickly return to generating excess returns for shareholders after a brutal 2016.

In our view, a slew of changes since the nadir of the food safety scare suggest that the firm’s brand intangible asset has materially strengthened, with operational efficiencies driving restaurant margin expansion to just shy of 30% in 2033 by our forecast, up from 26.2% in 2023, with digital investments increasing the brand’s resonance with digital native consumers, with pricing convergence with quick-service restaurants, or QSRs, allowing Chipotle to tap into a broader customer base, and with an assortment of other levers (daypart and menu expansion, premium beverage innovation, international development, assumption of leverage, refranchising) offering longer-term potential. 

More concretely, Chipotle’s operational enhancements, including the addition of a digital-only second-make line and the rollout of “Chipotlanes,” or order-ahead drive-thrus, have materially increased throughput capacity, allowing stores to offer competitive prices and make up the difference on volume. The introduction of the second make line appears particularly prescient, with digital orders still clocking around 35%-40% of total sales, even with a strong recovery of in-store traffic. Further, recent attention to seamless ordering across platforms, whether third-party delivery, white label delivery, mobile order and pickup, and traditional counter service represent the culmination of years of investment in the technology stack, with digital acuity likely to remain integral to the firm’s success moving forward. We believe that omnichannel ordering and a 38-million-member loyalty program provide a strong foundation for dynamic pricing, one-to-one marketing, funneling orders toward high-margin fulfillment channels, and driving data-driven menu innovation in line with customer demands. The firm’s success in the digital vertical is difficult to overstate—Chipotle’s digital sales per restaurant clocked in at nearly $1.1 million in 2023, which would have been good enough on its own to clock in within the top 50 U.S. restaurant chains by sales volume (per Technomic) on a standalone basis. Moreover, Chipotle has grown increasingly attractive to a price-sensitive clientele, with its chicken burritos and bowls selling for less than $10 in many markets and representing a viable alternative to many QSR offerings, while clocking in as much as 20%-30% cheaper than lookalike fast casual competitors. While foot traffic and app usage data indicate that Chipotle customers skew younger and more affluent than most pure QSR competitors, they also shop at fast food stalwarts like McDonald’s and Burger King, leading us to believe that the brand should not be considered in complete isolation from conventional QSRs. Instead, should average check continue to converge, and as Chipotle offers sufficient capacity, drive-thru convenience through Chipotlanes, and comparable or better speed of service to quick-serve peers, we expect a broader swath of the population to include the Mexican chain in its decision set for an affordable meal out. Finally, we view food safety risks as unlikely to materialize again at scale, with DNA-based bacterial testing upon delivery, sous vide meat preparation at distribution centers, third-party inspections, pre-shift employee wellness checks, mandatory hand-washing, and air purification systems representing some of the exhaustive steps the brand has taken to shore up its supply chain.

Turning to Chipotle’s brand intangible asset, we believe that robust comparable store sales performance, strong loyalty program uptake, and compelling unit economics attest to the brand’s strength, while forward-looking investments stand to entrench pricing power and affinity moving forward. In our view, comparable sales performance represents the most appropriate gauge of brand strength, with the best operators able to consistently outpace inflation with pricing power and increases in guest traffic. Over the past five years, Chipotle has seen median comparable sales growth of 8.1%, more than offsetting inflation during that period and comfortably outperforming the vast majority of industry competitors. While the firm has been historically reluctant to flex its pricing power—leaning instead on comparable transaction and mix growth—it was able to completely offset margin pressure from delivery costs during 2020 and 2021, raising menu prices by 17% in the channel and funneling orders toward more profitable mobile-order, Chipotlane, and in-store fulfillment, with minimal impact to volume. Chipotle’s success in defraying recent costs leaves us encouraged as restaurants are forced to adapt to a changing competitive environment, with labor and input cost inflation continuing to push higher in 2024 in no small part due to California's rollout of out an industry wage floor of $20, or roughly a 20% increase from today's going rate. 

Further attesting to its brand strength, Chipotle enjoyed 5% guest traffic growth through 2023 despite its own price increases and declining traffic industrywide, suggestive of meaningful pricing power and resonance with the firm's core customer base. Chipotle's loyalty program rollout has also proven encouraging, with 38 million registered members putting Chipotle in the same league as some of the most successful loyalty programs in the industry—Domino’s, Starbucks, and Panera. The burrito chain's performance is particularly impressive when one pauses to consider the much smaller scale of its domestic footprint (roughly 3,400 stores against more than 18,500 at the coffee giant). Importantly, loyalty program members have historically been highly incremental, and permit the firm to bolster sales through promotions and channel cross-selling, with just 15%-20% overlap between in-store and mobile app users. 

Rounding out our consideration of its brand intangible asset, we view Chipotle’s unit economics as among the best in the industry, with our estimates suggesting cash-on-cash returns between 50%-60% for full volume stores, suggesting a payback period just shy of two years. This suggests materially higher returns on investment than most competitive QSR concepts, which tend to see payback in four to six years, attributable to larger footprints and lower restaurant margins at the latter. While we often cite unit economics and growth as a proxy for franchisee health, given the Mexican chain’s majority company-ownership, we approach it in this case as reinforcing the firm’s high-single-digit (8%-10%) unit growth aspirations instead. While growth is not in and of itself evidence of a competitive advantage, it does allow Chipotle to generate scale over advertising expenditure, supply chain and quality assurance investments, (relatively) fixed labor and rent costs, and ongoing investments in the technology stack, allowing the firm to more effectively compete with larger QSR peers. Finally, though marketing expenses jumped sharply in 2016 (as the firm relied on free meals and discounting to drive traffic after food safety concerns), we note that trailing five-year figures of 2.6% of system sales are materially lower than wide-moat McDonald’s (4%), wide-moat Yum! Brands (4.5% at KFC, 6% at Pizza Hut, 5.5% at Taco Bell), and wide-moat Domino’s Pizza (5.5%), dispelling our concerns around a permanent uptick in discounting and promotional activity to buy comparable sales growth, which would point to brand impairment.

Finally, we view the likelihood of maintained economic value creation as quite high for the restaurant brand, which finds itself on the bleeding edge of most of the changes we expect to impact the restaurant industry over the medium to long term. Though Chipotle saw economic value destruction in 2016, we view the likelihood of similar events as exceedingly unlikely—and to the extent that an outbreak were to happen, supply chain tracing should allow it to be quelled more quickly and traced to its source, which represented perhaps the biggest systemic issue from the original incident. In our view, risks lie to the upside for the brand, which boasts an attractive following among an affluent, experience-oriented millennial and Gen Z customer base that spends materially more on eating out than older cohorts. Chipotle’s technological proficiency has already borne fruit, but a robust loyalty program and omnichannel ordering—increasing store capacity and allowing orders to be funneled toward higher margin channels—is a positive, while an order-ahead drive-thru eliminates the labor and payment pain points associated with the traditional QSR model. Further, $1.1 million in store-level digital sales offers longer-term potential, positioning Chipotle as one of the few operators in our coverage with viable aspirations to open smaller-concept, digital-only stores, which are heavily reliant on a brand and digital platform to drive traffic. Ultimately, we expect operating leverage over store-level expenses, corporate general and administrative expenses, and rental expenses to offer meaningful operating margin improvement as Chipotle has finally eclipsed pre-2016 average store sales figures, with operational efficiencies, higher margin premium beverages, Chipotlanes, and smaller format stores contributing to strong ROIC expansion—to 44% in 2033, by our estimates.

Wide

Economic Moat

Chipotle

Chipotle Mexican Grill, Inc. engages in the development and operation of classically-cooked, real food with wholesome ingredients without artificial colors, flavors or preservatives. It offers a focused menu of burritos, tacos, burrito bowls, and salads prepared using classic cooking methods. The company was founded by Steve Ells in 1993 and is headquartered in Newport Beach, CA.

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Chipotle Mexican Grill, Inc. engages in the business of developing and operating restaurants that serve a relevant menu of burritos, burrito bowls, quesadillas, tacos, and salads made using fresh, high-quality ingredients. The company was founded by Steve Ells in 1993 and is headquartered in Newport Beach, CA.