Chipotle (CMG)...the local burrito joint goes corporate...

Link to SEC S-1/A - Jan 23, 06

Chipotle is about to go public (ticker: CMG), and I watched the roadshow presentation last night on Retail Roadshow, a great site I've written about before. Here are a few thoughts based on my experience as a customer, reading the S-1 and watching management.

The Business: I love eating at Chipotle, I really do. No burrito place in NYC can compare, especially Burritoville (I mean, seriously, how does brown rice belong in a burrito?)

In college, I ate a damn lot of burritos. I've enjoyed this Mexican haute cuisine for many years. It is cheap, fast, and relatively healthy. As a working man with an aversion to cooking, if there had been more good burrito joints in NYC when I first got here, I would have extended this phase several years beyond college.

Unlike American "fast food," the ingredients for a good burrito are basic foods about as close to unprocessed as you can get: meat, beans (black), vegetables, tortillas. (Never mind chips and salsa.)

Now, I never actually checked the calories and fat content of the burritos I ate, and Chipotle conveniently has "not yet calculated this." But, with a little homework, Google Answers has a lengthy dialog estimating Chipotle clocks in at about 1,000+ calories. Not exactly "light" fare, but unlike a Big Mac and fries, a burrito is a hearty meal that will keep you going.

The Concept: Watching management, it's funny how they try to dress up the fact that they are basically the first truly national, corporate version of the typical local burrito bar. It jives me a little bit to hear them talk about how their model is innovative when it so blatantly is ripping off a model pioneered by Mexican migrants - credit where credit is due! In this spirit, I thought I'd point out a few ULLs (unintentionally laughable lines) from the management presentation:

• CMG says they are credited with having inventing "fast casual" dining - presumably titled so because burritos are as fast as fast food, and as wholesome as casual dining. Now, I agree that Chipotle is efficient, but I can't credit them with much more than paying attention to lines and staying true to the original vision of a simple process.
• CMG presented the fact that making burritos requires only a few inputs as a unique selling point - "only [around 130] SKUs in the process." Now, having eaten at Jack-in-the-Box (JBX) recently, it is clear that with about a thousand different items on the menu, this is a positive from a cost perspective. But, again, hard to see this as an innovation.
• CMG's stores are clean, bright and play snazzy music, and their food is from identifiable, earth-friendly sources, none of which can be said for most burrito bars. Now, this is somewhat of an innovation, as it helps them distinguish themselves from other fast food restaurants. But, I'd note that particularly at their price point, the "commitment to origins" isn't a requirement to do well. On the low end of the fast-food spectrum, McDonald's proved that you can build a global food powerhouse on deep fried mystery meats, and among firms on CMG's level, burrito places taste as good or better without special ingredients.

How about this for an easy way to explain the model? Chipotle is what burritos would be like if Starbucks sold them. (ed: We'll add to this the realistic possibility that burritos become the next hamburger.) Obviously, Starbucks doesn't take credit for running hot water over ground beans, and the idea of a nice place to sit and caffeinate yourself has long been a fixture of cities around the world. Starbucks' innovation was that you could make money off formerly-cheap products in a fragmented market through quality, "experience," and ubiquity, only one of which (ubiquity) is something that most fast food restaurants understand.

Key Risks: The two things I could think represent real risks to this business are:

Short-Term Risks:

• Realized growth rate slows along with store opening: I imagine that investors will over-extrapolate from the observed earnings growth rate, which was driven by a hectic pace of new store openings, to the future growth rate, which will be driven more by same-store-sales as store openings slow. This means the potential for a lot of optimism around the offering, followed by a "sobering up" period, as the business encounters limits to growth from the stores they have. You can see the planned vs. opened stores here:

Table of Open / Under Construction Restaurants (From S-1)

			Stores in operation		Stores under construction
Arizona			21		2
California			67		2
Colorado			55		—
District of Columbia			6		—
Florida			14		1
Georgia			10		—
Illinois			47		—
Indiana			6		—
Kansas			12		—
Kentucky			5		—
Maryland			21		—
Michigan			0		3
Minnesota			36		1
Missouri			8		1
Nebraska			6		1
Nevada			5		—
New York			13		1
Ohio			60		2
Oregon			5		—
Texas			60		—
Virginia			20		1
Washington			4		2
Wisconsin			8		—
	Total		489	(1)	17

Longer-Term Risks:

• Saturation of the US - not really on the horizon anytime soon, as you can see in the table above, but they're getting there. As long as the company has clear territory to open restaurants in, I think diners will continue to discover the pleasures of a tasty burrito. (Alaska could surely use a few burrito joints.) Open question: can we expect that burritos will become as popular as hamburgers or coffee? They are actually more popular in my family, so quite possibly.
  
• Increased competition in any of its major markets from Wendy's (WEN) "Baja Fresh" or CKE Restaurants' (CKE) "La Salsa". I haven't had La Salsa, but Baja Fresh is damn tasty. Burritos are a commodity, and there is no "best" way, and sometimes, frankly, the worse the origins of their ingredients, the better.

The Numbers: I'll take this summary from Forbes.com, although feel free to look through the IPO prospectus yourself:

In 2004, revenue totaled $470.7 million, up 130% from 2002 and 49% from 2003. The increase was driven by new-store openings and increased sales at existing stores. The company opened a total of 237 stores in 2002, 2003 and 2004. Average sales at new stores in the first 90 days of business increased about 29% to $303,390 in 2004 from $234,450 in 2002.

For the nine months ended Sept. 30, Chipotle reported net income of $33.4 million on revenue of $454.4 million, compared with net income of $9.8 million on revenue of $341.8 million for the same period in 2004. The company reported losses of $7.7 million in 2003 and $17.3 million in 2002. [...]

Of Chipotle's 489 stores open on Dec. 31, 2005, 184 had opened since Jan. 1, 2004, and rapid expansion is planned in the next three years. This could make future results uneven, and a misstep could hammer earnings. But more than that, Chipotle doesn't have an extensive operating history as an independent company, making it difficult to evaluate its future prospects.

Conclusion: I think I've about covered it, let me know if you would add any salient points.

I love the product, think that the growth prospects are good, and think that the company should do fine. Hot trading around IPO pricing will make this one tough for small investors to get into initially. - Ed

Reminder: Please see disclosure at right.

Comments

[eh]

On the surface this reminds me of RUBO, another Mexican fast food joint that went public a few years ago. Anyone who bought RUBOt at the IPO price -- $15/share, as I recall -- is still in the red, assuming they held. Tough, low margin business.

[Stephanie O]

you were right. i was wrong. stock opened at $45 with a $22 ipo price. i am still right though that the mexican in california will beat a chipotle's burrito anyday.

[Big Mike]

Great overview! But what's missing is the price/sales ratio at the current stock price, and how that compares to the price/sales ratios of other fast food chains.

[Sam]

Good analysis of the Chipotle IPO here

http://stocksandfunds.blogspot.com/