Long Lines,  Big Burrito,  Full Belly.  Chipotle. 

The beauty of Chipotle is the simplicity of the restaurant.  Let’s not complicate our analysis with anything more than a back of envelope sketching of its valuation.

At roughly 2,350 locations, Chipotle is on track to do an average of $1.95m per location or approximately $4.6B per year.

Sketching out a new 200 locations per year (100 for the remainder of 2017), Chipotle would have 3,250 locations at the end of 2021.

Let’s make some assumptions.  Peak revenue per location (referred to as AUV–average unit volume) was $2,532. And peak operating margins (inclusive of restaurant level expenses (71.7%) and SG&A expenses (5.8%) ) was 22.5%.

Currently, Chipotle is running at operating margins of 12.8% (inclusive of restaurant level margins (81.2%) and SG&A expenses (6%)).

Hopefully that Full Belly did not make you sick (I doubt it did), but you can clearly see that Chipotle has taken a hit.

AUV has declined 22% and margins have declined 43%.  It has certainly made Chipotle shareholders sick.

What does the future hold?

Our napkin projections don’t aim for pies in the sky (still feeling groggy from the burrito).

If you “conservatively” estimated that Chipotle would be back to its historical sales and margins within months of the E. Coli outbreak, you are still waiting at 22 months.

Let’s instead assume Chipotle’s SSS (same store sales) increase by 2% per year until 2021 and the margins make it half way back to their peak (17.5% operating margins).

At the end of 2021, this would give us the following

Locations: 3,250

AUV: $2.12 (still 16% below peak of $2.5m)

Sales: $6.9B

Operating Earnings: $1.2B

Net Income: $785m

Earnings Per Share (28.5m shares): $27.5

Cash on Balance Sheet: $85 per share

[There is some rounding in my numbers]

If we assume the market values Chipotle’s 2021 earnings at 20x, the share price will be $635 ($550 (27.5 x20)+$85 per share in cash).  I use 20x earnings because in 2021 with 3,250 locations, I don’t see Chipotle being a huge growth company at that point.

Today’s stock price is $350 (at the time of this writing).  If the stock price reached $635 towards the end of 2021, the return would be roughly 16% annualized.  This is a good return and almost certainty beat the S&P over that time period.

However, nothing is precise and there are a few key assumptions.

  1. You can throw your napkin in the trash if there is another (or multiple) new health incidents.
  2. New locations are most likely to be less lucrative than the older locations, potentially decreasing the overall AUV as Chipotle moves into less dense geographies.
  3. You are projecting something 5 years away.

A few related points.  John wrote a great post about Return on Incremental Invested Capital about a year ago, highlighting Chipotle’s numbers.  Return on incremental investments are inherently backwards looking because each new dollar of invested capital has risk that the return on each “new dollar” of capital will not equal past returns.  This is certainly the case with Chipotle.

Fad or trends tend to have huge incremental returns on capital as the business is booming, so each new dollar of invested capital looks like a great investment.  However, saturation and the potential for the business to lose its appeal can impact each incremental dollar of capital.  This is the “big question” going forward with Chipotle.  Has the Chipotle fad faded?  Will each new location perform at lower sales figures going forward as they press into lower density locations?  Restaurants and fashion apparel tend to show huge returns on incremental invested capital when they are “in”, however, within a short time period, these trends can change and the names disappear (Aeropostale comes to mind).

I don’t really know the answers to these questions and thus I do not think the margin of safety is adequate at these price levels.  If the stock continues to decline coupled with a consistent improvement in same store sales and margins, I think Chipotle could make a reasonable investment.  One thing I think Chipotle has cracked is a restaurant that has a simplified menu and operations to be consistently profitable.  This is one of the main reasons I am keeping it on my watchlist.

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