Chipotle (a fast-food restaurant that offers Mexican food) crushed the S&P500 with its share price performance (up 260% in the last 5 years) and is currently trading around $1500/share at a P/E of over 65.
This post is my attempt to analyze the company to its fundamentals, set certain assumptions about the future, and calculate its intrinsic value.
Revenue – Let's start with the top-line
In the last 5 years, the company's revenue was growing at around 10% year over year, except 2021, when it increased 26% ($4.5b in 2017 to $7.5b in 2021). There are a few reasons for this increase, one of them is the price increases on its menu.
If I put myself in the shoes of Chipotle management, I can think of a few ways to grow revenue:
- Increase the # of locations – the most obvious way to increase revenue as the physical location is key to its operations. If the number of locations increases by 20%, it is rational to expect a revenue increase by 20% (assuming everything is equal).
- Increase in prices/inflation – This is not something that happens that often, but restaurants do increase the prices from time to time, inflation being one of the main reasons behind it.
- Sell more products through its existing locations by increasing the product offerings.
- Implement Chipotlane at more locations (Chipotlane is a drive-thru pickup lane, currently available at 12% of Chipotle locations)
Location, location, location
Chipotle has around 3.000 restaurants (as of 2021) and the management expects to increase the # of restaurants to 7000 in North America. The number of locations historically has increased by 10% year over year, so it is reasonable to expect a similar path forward. Does that mean the revenue is expected to grow at the same pace? I'd say that should be the minimum forecast. Let's not forget the other 3 points above, especially adding Chipotlane to its existing locations.
It is worth mentioning that unlike McDonald's, Chipotle doesn't offer franchise opportunities, so all of the locations are managed by them.
Analysts are forecasting annual growth between 13% and 18% for the years to come, which is in line with my expectations.
With 3.000 restaurants out there, Chipotle has a lot of room to grow, both in the US and internationally For comparison purposes: Wendy's has 6.5k locations, Taco Bell – 7k, Dominos – 18k, McDonald's – 38k, Subway – 42k
Operating margin
The restaurant industry is known for having relatively low margins. As for Chipotle, the operating margin increased from 6% in 2017 to 10% in 2021. The margin expansion has just started and will continue in the years to come.
Analysts are forecasting expansion to 16% in the next 2 years.
Financing, debt/equity
The company has no debt apart from the $3.5b capital leases, so the debt/equity ratio is therefore fairly low. The Property, plant and equipment amount on the balance sheet is just below $5b. This means most of the locations where Chipotle operates are leased.
Key assumptions
Based on the notes above, my assumptions are the following:
Revenue growth: 14% annually until year 5, then slowly declining to the risk-free rate up to year 10
Operating margin: Slowly increasing to 18% in year 6 then remaining at that level.
Discount rate: WACC – 8.13%
There are two main reasons for my revenue growth decline:
- As a company grows bigger, it is more difficult to grow, I don't think Chipotle will be any different in that regard.
- Less than 100 of its 3k locations are outside of the US. If the company grows internationally, it will be exposed to different kinds of environments and the expected expansion might have some challenges. Operating a fast-food chain that serves Mexican food won't be the same in the US as in Asia, LATAM, or EMEA.
Outcome
Running the above assumptions through a DCF, the outcome is $878/share, way below its current price of around $1500.
I could definitely be wrong, so below is a simulation with different assumptions regarding the revenue in 10 years from now and the operating margin:
| Revenue / Op. margin | 16% | 18% | 20% |
|---|---|---|---|
| 150% ($18.9b) | $677 | $780 | $884 |
| 182% ($21.3b) | $760 | $878 | $995 |
| 230% ($24.9b) | $851 | $985 | $1118 |
| 300% ($30.2b) | $980 | $1136 | $1291 |
The company seems undervalued during 2017/2018, then slowly caught up to its fair value in 2019. However, after that, I cannot find a fundamental reason to justify its surge. In my opinion, it seems that there was a lot of FOMO around it. Don't get me wrong, it is a great business, it is growing healthy, with relatively low debt and good liquidity and great management decisions have been made. However, it seems too expensive at this price.
The expected EPS for 2024 is $53.5 which leads to a ridiculously high forward P/E (roughly 30x of 2024 earnings)
Could I be wrong? Absolutely! I'd like to hear your thoughts on the company as we all get better by sharing views and opinions, especially when we disagree on certain topics.
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