Nobody is going to tell you that Chipotle (CMG) is not a good company. Many, however, may tell you that Chipotle will not be a great stock if it slips up in any way. Said in no uncertain terms, the company is priced to perfect execution, and this represents the biggest risk holders of Chipotle’s equity face when dabbling in shares. As we recently saw with Netflix (NFLX), high-flyers can take a huge hit if they come in only slightly lower than investor expectations for any given period.
It’s very difficult to find fault in the burrito-maker’s third-quarter performance. Revenue increased a whopping 31%+, to $1.08 billion while comparable restaurant sales advanced 19.8%. For those unfamiliar with the restaurant arena, a near-20% comp is very impressive. Furthermore, Chipotle put up this same-store-sales growth while driving restaurant level operating margins 200 basis points higher, to 28.8%. Net income leapt ~57%, while diluted earnings per share jumped by a similar margin. Most of the strong comp gains were driven by increased traffic, though pricing helped to offset rising food costs from beef, avocados, and dairy. Chipotle had rolled out a nationwide menu price increase that completed just before the third quarter. Very few restaurants in the world are growing “comps” at a ~20% clip.
Image Source: Chipotle
Clearly, the Chipotle model is resonating extremely well with customers. During the period, the firm opened 43 new restaurants, bringing the total count to 1,724 at the end of the quarter. On the basis of same-store sales expansion, there should be plenty of room for additional locations, even in areas that previously had thought to have been saturated. The competition from Yum! Brands’ (YUM) Taco Bell resurgence has not had any sustained or measurable impact at this point, and we think Taco Bell’s shift to combat McDonald’s (MCD) in the breakfast arena speaks volumes about Chipotle’s dominance in the fast-casual burrito space. Chipotle is not yet ready to enter the breakfast space…yet.
Looking ahead to 2015, management expects to open as many as 205 new restaurants, slightly more than the 180-195 expected during this year. Next year’s comp growth is expected to slow to the low-to-mid-single digits, but we think this has more to do with management being conservative than anything else. We only have to look to the beginning of this year to see that management expected the same growth for 2014. Through the first nine months of 2014, same-store sales are up 17%! All is well at Chipotle.
Still, investing is about identifying mispriced assets, not owning the fastest-growing or most exciting company. Shares of Chipotle cost a pretty penny on the basis of future expected free cash flows, and we think there will be a better to time to enter the position in the future. No firm can execute perfectly forever, and we’ll evaluate adding shares of the burrito maker to the Best Ideas portfolio only when valuation makes sense – and that includes an appropriate margin of safety. We also think paying close attention to Buffalo Wild Wings’ (BWLD) PizzaRev is worthwhile. Buffalo Wild Wings is planning to do to pizza what Chipotle has done to burritos, and we don’t think the market is appropriately pricing in that opportunity.