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Chipotle Equity Analysis_An Expensive Burrito?


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Chipotle (CMG) fundamental analysis

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Chipotle Equity Analysis_An Expensive Burrito?

  1. 1. ChipotleAn Expensive Burrito?
  2. 2. Chipotle – The BusinessTicker CMGMarket Cap ~9.4 BillionMarket Price $298.73Trailing P/E ~34.7xForward P/E ~ 28.67xSharesOutstanding31.5 MillionStock Beta 0.48Chipotle (CMG) currently develops and operates Fast-casual, Mexican Taqueriainspired restaurants. The menu is focused on burritos, tacos, burrito bowls, andsalads. As of September 30, 2012 CMG operated 1350 restaurants includinginternational locations in London (5), Toronto (4), and Paris (1).Chipotle was founded in 1993 by Steve Ellis who unknowingly became a pioneerin the Fast-casual segment of the restaurant industry by reimagining andrepackaging traditional Mexican inspired cuisine.“Food with Integrity”Chipotle focuses on fresh, sustainable ingredients meeting specific qualitystandards. The firm specifically sources and develops relationships with farmersand distributors who meet or exceed these standards. These standards include“naturally raised” pork, beef, and chicken defined as animals whose lifecycleincludes a proper vegetarian diet and does not include the use of antibiotics,growth hormones, or feed additives. Their dairy cattle are pasture-raised withdaily access to outdoor pastures, they are also “naturally raised” without the useof recombinant bovine growth hormone (rBGH).Quickfact data sourcedfrom YahooFinanceintradayon1/07/2013. BusinessinformationsourceddirectlyfromChipotle.comQuick Facts:
  3. 3. Chipotle – The Business StrategyTicker CMGMarket Cap ~9.4 BillionMarket Price $298.73Trailing P/E ~34.7xForward P/E ~ 28.67xSharesOutstanding31.5 MillionStock Beta 0.48When Chipotle began operations in 1993, Steve Ellis sought to address the pain pointshe experienced at the traditional taqueria’s in San Francisco that inspired his vision. Theprimary issues were tight, small spaces with only 1 or 2 people working the kitchen tomeet demand. By applying the Ford assembly line model to this niche Steve Ellisbelieved he could serve a much larger volume of customers while still adhering to hisprinciples of high quality, good tasting food that he developed in culinary school.Chipotle seeks to minimize pre-opening costs. Each restaurant has a minimalist,industrial design focus that can also be called stylish. This serves two purposes thatCMG has leveraged in their business model. (1) Restaurant development costs areinexpensive – the rebranding and interior design process does not require specializedparts or materials and can be sourced locally anywhere. (2) Minimalist, industrialdesigns are famously adaptable to fit specific needs, spaces, and limitations. This allowsCMG flexibility in choosing restaurant locations and design customizations helping keepthe brand itself “fresh”. Approximately 99% of their restaurant spaces are leased insteadof purchased and built; again focusing on minimizing pre-opening costs.The “Food with Integrity” mantra has helped strategically position CMG to exploitcurrent trends. Over the last two decades there has been a cultural shift in the U.S. aspeople concerned with the growing obesity, diabetes, and heart disease rates soughtalternative higher quality food options that still provided some “fast food” elements.Chipotle provides this with the focus of serving each customer in 90 seconds or less,using quality fresh ingredients and perhaps more importantly, providing this service atthe price point between $6-$10. This is precisely in the mid point above traditional fastfood of $5 or less, and lower than sit-down casual-dining restaurants of $10 or more.This provides an additional advantage because fast food is associated with poor qualityingredients and more expensive casual dining restaurants are often comparable orworse than CMG in ingredient quality. This provides high value to customers.Quickfact data sourcedfrom YahooFinanceintradayon 1/07/2013. BusinessinformationsourceddirectlyfromChipotle.comQuick Facts:
  4. 4. Chipotle – Balance Sheet AnalysisTicker CMGTotal Cash(mrq):573.89MTotal Cash PerShare (mrq):18.22xTotal Debt(mrq):3.56MTotalDebt/Equity(mrq):0.27xCurrent Ratio(mrq):4.12xBook Value PerShare (mrq):41.43xChipotle operates primarily as a cash based business with significant liquid assets andlittle to no leverage and minimal debt. A quick look at some key ratios andcomparisons to the industry and sector lend support to this analysis.FINANCIAL STRENGTHCompany Industry SectorQuick Ratio (MRQ) 4.06 1.05 1.27Current Ratio (MRQ) 4.12 1.18 1.64LT Debt to Equity(MRQ)0.26 48.93 32.72Total Debt to Equity(MRQ)0.27 72.46 55.28Interest Coverage(TTM)344.46 33.27 67.62CMG’s financial health dominates restaurant industry and services sector comparisonsin terms of liquidity, debt and leverage. With it’s current ratio almost 4x the industryaverage and Total Debt to Equity only 0.37% of industry average, CMG is in a league ofit’s own.Quickfact data sourcedfrom YahooFinanceintradayon 1/07/2013. TableData sourcedfrom Reuters.comQuick Facts:
  5. 5. Chipotle – Cash Flow AnalysisAccording to SEC filings CMG has grownit’s Net Operating Cash at a 34%Compound Annual Growth Rate (CAGR)with cash flows increasing from $39.7million in 2004 to $411.1 million in 2011.Since Chipotle’s public offering in 2006the firm has steadily increased it’s TotalFree Cash Flow to Equity from $23.2million in 2007 to $235.7 million in 2011representing a 59% CAGR.As discussed earlier, Chipotle’s businessmodel leverages their design philosophyinto relatively inexpensive developmentand maintenance costs with a 5 periodaverage of $134.8 million in CapEx peryear.-$200,000-$100,000$0$100,000$200,000$300,000$400,000$500,000Sum of2011Sum of2010Sum of2009Sum of2008Sum of2007Sum of2006Sum of2005Sum of2004Cash Flow Chart (in thousands)Net cash provided by operating activitiesNet cash used in financing activitiesPurchases of leasehold improvements, property and equipment, netTotal FCFEDatasourcedfrom combinedSEC 10K filings.
  6. 6. Chipotle Restaurant Location Breakdown• As of September 30, 2012 CMG operated 1,350 restaurants of which 1,340 are U.S. based. Using July 2011 U.S. censusdata of a domestic population of 311,591,917 that equates to 1 Chipotle for every 232,358 Americans. Forcomparisons sake in 2009 there were 13,000 domestic McDonald’s(1) or 1 location for every 23,000 Americans.• With location growth averaging 16.7% per year since 2005 and the Fast-casual dining segment tripling it’s marketshare to 6%(2) of the restaurant industry in 2011 there is much room for domestic expansion.2005 2006 2007 2008 2009 2010 2011Total Store Growth YoY 18.81% 21.17% 18.89% 14.22% 13.39% 13.47%0%5%10%15%20%25%%RestaurantGrowthTotal Restaurant Percentage Growth YoY(1) (2)
  7. 7. Chipotle Restaurant Location Breakdown (as of Dec 31, 2011)02004006008001000120014002005 2006 2007 2008 2009 2010 2011CanadaUnited KingdomWyomingWisconsinWashingtonVirginiaUtahTexasTennesseeSouth CarolinaRhode IslandPennsylvaniaOregonOklahomaOhioNorth CarolinaNew YorkNew MexicoNew JerseyNew HampshireNevada
  8. 8. Wow! A great niche, strong cash flows,excellent balance sheet and room forgrowth?!This stock seems great! I need to call mybroker and Buy!
  9. 9. "Its far better to buy a wonderful company at a fairprice than a fair company at a wonderful price.“- Warren BuffetWhat is the fair price forChipotle?
  10. 10. Valuation RatiosCompany Industry SectorP/E Ratio (TTM) 34.89 51.08 15.84P/E High - Last 5 Yrs. 69.08 74.94 32.20P/E Low - Last 5 Yrs. 22.31 24.04 9.50Beta 0.85 0.30 0.93Price to Sales (TTM) 3.60 3.45 1.47Price to Book (MRQ) 7.24 11.75 1.56Price to Tangible Book (MRQ) 7.35 13.01 2.63Price to Cash Flow (TTM) 26.61 27.64 9.42Price to Free Cash Flow (TTM) 43.29 14.66 29.59Chipotle Valuation AnalysisTo answer the question about what is the fair price, we haveto consider what is the intrinsic value of the stock relative tothe price paid.Using some common ratios as a basis for answering thisquestion we can see that CMG’s P/E Ratio of 34.89x isapproximately 1.5x less than the restaurant industry’saverage P/E Ratio of 51.08x representing a relative 46%discount for the investor.*Note: Yahoo Finance Restaurant Industry P/E is 20.09x,representing a 71% premium the investor must pay to ownCMG shares!!CMG’s Price to Sales is comparable to the industry average,while the Price to Book and Price to Tangible Book are 38%less and 44% less than industry averages respectively.Price to Cash Flow is also comparable to industry averages,however CMG’s Price to Free Cash Flow of 43.29x is nearly 3xhigher than the industry average of 14.66x -- Why pay sucha high multiple for those cash flows? I think the answer maylie in the growth numbers.Tabledatasourcedfrom Reuters.com1/07/13
  11. 11. Chipotle Valuation AnalysisExamining the growth table there are two key takeaways withrespect to the premium price paid for Chipotle’s cash flows relativeto industry averages.The most obvious observation is that Sales and EPS are growthpositive for CMG and the restaurant industry as a whole both on acurrent basis and 5 Yr average.Not only are these key variables growth positive but Sales and EPSare growing at a blended 18.6% and 30.5% 5 Yr average respectively.Looking at CMG’s 5 Yr Growth Rate of Sales compared to theindustry average we see that CMG’s 22.49% is 1.5x greater thanindustry average while CMG’s EPS 5 Yr Growth Rate is 1.8x industryaverage.This growth picture certainly presents a compelling case for placing apremium on CMG’s cash flows ... but is the premium too high?Growth RatiosCompany Industry SectorSales (MRQ) vs.. Qtr. 1 Yr.Ago18.36 14.80 16.85Sales (TTM) vs.. TTM 1 Yr.Ago21.97 16.81 15.24Sales - 5 Yr. Growth Rate 22.49 14.78 8.78EPS (MRQ) vs. Qtr. 1 Yr. Ago 19.58 19.10 68.20EPS (TTM) vs. TTM 1 Yr. Ago 33.98 -- --EPS - 5 Yr. Growth Rate 39.60 21.41 16.24Capital Spending - 5 Yr.Growth Rate9.21 9.53 4.45Tabledatasourcedfrom Reuters.com1/07/13
  12. 12. Chipotle Valuation Analysis20112010200920082007200620052004200320022001EBIT Margin 15.45%15.68%13.42%9.31%9.96%7.53%4.94%1.30%-2.51%-8.62%-18.79%NI Margin 9.47%9.75%8.35%5.87%6.50%5.03%6.01%1.30%-2.44%-8.45%-18.24%-25.00%-20.00%-15.00%-10.00%-5.00%0.00%5.00%10.00%15.00%20.00%MarginsIncome MarginsThere are particular challenges to the current growth picture forCMG. To command a premium for the price paid, a growth stockshould still be in a “high” growth stage. It can be argued that CMGis still in high growth, however I see trends emerging to suggestburgeoning maturation and stable growth.In the chart below, EBIT and Net Income Margin showed stronggrowth from 2001 until 2009. From 2009 until 2011 we see marginsbeginning to stabilize, with EBIT averaging 14.9% and NI averaging9.2% for the period.In the chart below we see that revenue growth is strongaveraging 33.65% since 2002. However, there is a definitivedowntrend to observe.This is to be expected as CMG continues to grow in size andmore competitors enter the Fast-casual dining segment of therestaurant industry.2011201020092008200720062005200420032002Revenue Growth 23.62%20.91%14.00%22.67%31.94%31.10%33.35%49.19%54.18%55.51%0.00%10.00%20.00%30.00%40.00%50.00%60.00%GrowthRevenue Growth YoY
  13. 13. Chipotle Valuation AnalysisR² = 0.2971-20%0%20%40%60%80%100%120%140%Q42012Q32012Q22012Q12012Q42011Q32011Q22011Q12011Q42010Q32010Q22010Q12010Q42009Q32009Q22009Q12009Q42008Q32008Q22008Q12008Q42007Q32007Q22007Q12007Q42006Q32006Q22006Q12006Earnings Surprise Percentage by QuarterEarnings Surprise Linear (Earnings Surprise)Below I have charted the earnings surprise percentage since 2006 by quarter. Although the R2 is low for thelinear regression, we can see there has been a definitive downtrend in terms of the magnitude of positiveearnings surprises. The graph shows that analysts are better forecasting earnings, therefore managinginvestor expectations which I interpret as negative for upside stock momentum. For investors paying highpremiums to own the equity, simply meeting expectations may only cause the stock to tread water while anearnings miss could prove disastrous.EarningsDatasourcedfrom ThomsonReuters
  14. 14. Chipotle DCF Valuation AnalysisUnlevered Free Cash Flow CalculationCalendar Year Ending December 31, CAGR2011A 2012P 2013P 2014E 2015E 2016E 2008-2012EBIT $350.6 $417.5 $511.9 $627.8 $769.9 $944.0 22.6%Plus: Non-deductible Goodwill Amort. - - - - - -EBITA $350.6 $417.5 $511.9 $627.8 $769.9 $944.0 22.6%Less: Provision for Taxes (122.7) (146.1) (179.2) (219.7) (269.5) (330.4)Unlevered Net Income $227.9 $271.4 $332.7 $408.1 $500.4 $613.6 22.6%Plus: D&A (excl. non-deductible GW amort.) 86.6 106.2 130.2 159.6 195.7 240.0Less: Capital Expenditures (134.8) (146.9) (160.2) (174.6) (190.3) (207.4)Less: Increase in Net Working Capital (60.6) (72.0) (80.0) (85.0) (72.0) (60.6)Unlevered Free Cash Flow $119.1 $158.6 $222.8 $308.1 $433.9 $585.6 38.6%CapEx Rate 9.0%Tax Rate 35.0%Net Debt ($20.3)Shares 31.500CAPM Assumptions10 Yr Treasury Yld 1.92%Beta 0.48Equity Premium 6.20%Ke 5.82%DCF Analysis (2012-2016): EBITDA Multiple MethodTotal Enterprise Value Total Equity ValueTerminal EBITDA Multiple Terminal EBITDA Multiple10.0x 12.0x 14.0x 10.0x 12.0x 14.0xDiscount 6.0% $8,442.0 $9,852.8 $11,263.6 Discount 6.0% $8,462.3 $9,873.1 $11,283.9Rate 7.0% 8,073.4 9,419.6 10,765.7 Rate 7.0% 8,093.7 9,439.9 10,786.0(WACC) 8.0% 7,724.6 9,009.6 10,294.5 (WACC) 8.0% 7,744.9 9,029.8 10,314.8Implied Perpetuity Growth Rate Total Price Per ShareTerminal EBITDA Multiple Terminal EBITDA Multiple10.0x 12.0x 14.0x 10.0x 12.0x 14.0xDiscount 6.0% (0.2%) 0.8% 1.5% Discount 6.0% $268.64 $313.43 $358.22Rate 7.0% 0.8% 1.7% 2.5% Rate 7.0% 256.94 299.68 342.41(WACC) 8.0% 1.7% 2.7% 3.4% (WACC) 8.0% 245.87 286.66 327.45DCF Analysis (2012-2016): Perpetuity Growth MethodTotal Enterprise Value Total Equity ValueTerminal Perpetuity Grow th Rate Terminal Perpetuity Grow th Rate2.0% 2.5% 3.0% 2.0% 2.5% 3.0%Discount 6.0% $12,546.4 $14,203.0 $16,411.8 Discount 6.0% $12,566.7 $14,223.3 $16,432.1Rate 7.0% 9,860.3 10,853.0 12,094.0 Rate 7.0% 9,880.6 10,873.3 12,114.3(WACC) 8.0% 8,075.2 8,727.3 9,509.9 (WACC) 8.0% 8,095.5 8,747.6 9,530.2Implied Terminal EBITDA Multiple Total Price Per ShareTerminal Perpetuity Grow th Rate Terminal Perpetuity Grow th Rate2.0% 2.5% 3.0% 2.0% 2.5% 3.0%Discount 6.0% 15.8x 18.2x 21.3x Discount 6.0% $398.94 $451.53 $521.65Rate 7.0% 12.7x 14.1x 16.0x Rate 7.0% 313.67 345.19 384.58(WACC) 8.0% 10.5x 11.6x 12.8x (WACC) 8.0% 257.00 277.70 302.55
  15. 15. Chipotle Valuation Analysis – Thoughts and ConclusionsLooking at the DCF model provides guideline estimates for the intrinsicvalue of CMG equity. Looking at the estimates using the 3% terminalgrowth rate column, which coincides with Fed estimates of 2013 GDPgrowth, we see over a range of discount rates that CMG equity at acurrent price of $297.67 per share is undervalued.Another angle to observe is earnings yield compared to 10 year Treasuryrates. Year to date earnings are $6.86 per share compared to the currentprice of $297.67 which equates to a yield of 2.3%. This is only a 0.38%excess return compared to the 10 yr yield of 1.92%However, if FY12 annual earnings come in near consensus estimates at$8.90 per share with today’s share price, then the earnings yield is 2.98%which equates to a 1.06% excess return. Over 10 years that equates toroughly 10.6% excess return over Treasury yields all else equal.Depending on your risk aversion characteristics, CMG stock could be agreat buy. However, I am not convinced. I will detail my reasoning in thenext slide.Total Price Per ShareTerminal Perpetuity Growth Rate2.0% 2.5% 3.0%Discount 6.0% $398.94 $451.53 $521.65Rate 7.0% 313.67 345.19 384.58(WACC) 8.0% 257.00 277.70 302.55
  16. 16. Chipotle Valuation Analysis – Thoughts and ConclusionsAn Expensive BurritoChipotle equity does not currently present good value to the investor forthe following reasons:1. As a “growth stock”, CMG is beginning to show signs of a maturingbusiness. Revenue growth is trending downwards, and margins arestabilizing which acts as a P/E compressor.2. As a “growth stock”, earnings momentum has trended downwards foryears and stalled over the last 18 months, setting up investors who are“late to the party” for disappointment, even if earnings targets are in-line.3. Earnings yield compared to 10 year Treasury yield is too low to justifythe price premium. With no dividend expected, 10% excess return toTreasuries over a decade is not good value especially if CMG is marketedas a “growth stock”. This is assuming the consensus earnings target forFY12 of $8.90 is met.4. Chipotle’s use of cash is of concern from an investor perspective. SinceOctober of 2012 the company has authorized $200 million in sharerepurchase programs. Is there any wonder why? Per Yahoo finance, fromFebruary 2011 to December 2012 management has sold approximately820,000 shares for a gross notional value of ~$2.3 billion. It would seemthat executives would like to limit the effects of dilution on thecompany’s share price and float.5. Finally we come to the competition. The Fast-casual segment of therestaurant industry is growing and Chipotle may have the largest share,but competitors are everywhere. Qdoba, Taco Bell (offering healthieroptions), Bolocco, local Taqueria’s et al are all competing for marketshare. The niche Chipotle occupies is becoming crowded. The product,while good, is not so differentiated. This always leads to margincompression.The factors outlined above lead me to conclude that the price premiumnecessary to acquire CMG’s earnings and cash flows does not presentgood value or a proper risk-reward ratio to the investor.
  17. 17. Presented By Brian ChristopherAny questions comments or concerns contact:Brian Christopherkngllc@gmail.com617.642.9211