![\"Chipotle](\"https:\/\/businessecon.org\/wp-content\/uploads\/Chipotle-Mexican-Grill.jpg\")
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Provide Food With Integrity – <\/span><\/strong>Chipotle Mexican Grill, Inc. Mission Statement<\/span><\/p>\n Chipotle Mexican Grill, Inc.’s current (01\/24\/22) market price is around $1,400 per share, trading as high as $1,930 late last summer (summer of 2021). The market price is hyped up on the strong belief that this company will generate incredible results over the next few years. The truth of the matter is this: even if you took the absolute best quarterly result from the last five years, extrapolated that value as the normal value for Chipotle, then doubled its growth rate, the maximum best value for Chipotle would equal $480 per share. To put this succinctly, the market price for stock is so overpriced that the best term to describe this is ‘irrational exuberance’ (Alan Greenspan, December 5, 1996).\u00a0<\/span><\/p>\n There is no doubt this company produces a great product that is loved by millions of consumers. Even more, Chipotle has grown in leaps and bounds with volume of restaurants over the last ten years (adding 1,300 restaurants in eight years); it currently has 2,900 locations. More importantly, Chipotle’s gross margin has improved to a respectable 11.9%. Add to this, Chipotle has not recorded a loss during the last ten years. However, Chipotle’s financial model does not mirror the fast-food restaurant financial model customarily found with franchised operations such as McDonald’s<\/span><\/strong><\/a>, Wendy’s, Restaurant Brands International and Dominos. Furthermore, the law of diminishing returns will begin to dampen growth and impact the ability of Chipotle to maintain a high quality meal. In effect, the growth experience that Chipotle has seen can not endure. Instead of seven and eight percent annual growth rates experienced over the last ten years, growth will shrink to a more realistic four and five percent per year.\u00a0<\/span><\/p>\n The growth rate is one of the three most important elements when determining value. Using Graham and Dodd’s famous intrinsic value formula advocated from their life’s work (Security Analysis<\/em><\/strong>), value equals average yearly earnings over the last three years times ((8.5 plus (2 times expected growth, as an absolute value, over the next seven years)). This turns out as follows:<\/span><\/p>\n VALUE<\/strong> = Average Earnings of $10.57 times ((8.5 + (2X5)), assumes a 5% average growth rate for the next seven years;<\/span> In general, Chipotle Mexican Grill, Inc.<\/span><\/strong><\/a> is worth about $196 per share. Many readers will find this unbelievable given the fact that the market’s current price is over $1,400 per share. How can this dramatic difference exist? This article will answer this and substantiate that indeed the intrinsic value is less than $180 per share. Optimum buy price is around $153 per share which provides a reasonable margin of safety for the investor. Furthermore, it will explore how the market has driven the share price to such an irrational level of value.<\/span><\/p>\n To the reader, you have to be realistic about this situation. NO COMPANY THAT EARNS LESS THAN $25 PER SHARE PER YEAR IS WORTH MORE THAN $600 PER SHARE.<\/strong><\/span> There are no justifiable characteristics that can substantiate such ludicrous values over $600 per share. Any credible resource, accountant, finance guru, or economist will tell you this. If anyone says otherwise, their educational background and experience should be questioned. The simple truth is that buyers and sellers of this stock are conducting business on speculation and not sound business principles. Do not get caught up in that foolish behavior.<\/span><\/p>\n To gain an understanding of intrinsic value for any company, the first step is to gather the core financial elements of the operation; one must understand the company’s financial matrix. Next, using this information, a value investor generates several different value points and compares them against industry models to determine this particular member’s position in the hierarchy of potential investment among this member’s pool. With this knowledge, several different intrinsic value formulas are applied and using a compare\/contrast thought process, the value investor can develop a reasonable intrinsic value for this investment. Furthermore, risks are explained and why it is so important to create a margin of safety related to intrinsic value as the buy point for this security.<\/span><\/p>\n The final sections will explain how the market has driven this particular stock’s price so high. It finishes with the optimum sale price if the opportunity to buy develops and is exercised. But to get to this point, the value investor must first understand the core financial elements.<\/span><\/p>\n Thus, one of the core financial elements is volume; how much are the stores producing in sales and is it growing? For Chipotle Mexican Grill, Inc., look at their sales volume per store for the last seven years:<\/span><\/p>\n \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0Sales\/Store<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0# of Stores<\/span><\/strong><\/span> Yes, sales are growing per store and the volume of stores are also growing each year. But there is a catch here; notice how sales per store in 2020 have not reached the same volume of sales as recorded at the peak back in 2014. Though, some good news here, as of the third quarter 2021 and extrapolating into the fourth quarter 2021, sales volume per store has reached a lifetime new peak of $2,554,000.\u00a0<\/span><\/p>\n Thus, there are two distinct growth contribution factors. First, sales per store are improving two to three percent per year with a significant increase in 2021 (which was experienced by the entire fast-food industry across the board). Secondly, the number of stores are increasing five to six percent per year which is the primary reason overall sales are having such an outstanding increase from one period to the next. Overall, better than average industry growth exists for Chipotle. When evaluating growth, the value investor is really interested in a reasonable expectation of growth over the next seven years. Assuming no economic downturns such as a recession and the lifting of all COVID-19 restrictions, it is reasonable to expect a good growth of four to six percent per year for the next seven years. Therefore, any value within this range would be considered Chipotle’s growth rate.<\/span><\/p>\n In addition to growth, other financial related values are necessary. One of the critical pieces is the overall operating margin per year. Basically, a value investor wants to know, how much is the company as a whole netting with its income from one year to the next and what is this particular value’s growth rate. Here is Chipotle’s operating income from the last eight years and the expected amount for 2021 given information through the third quarter 2021 extrapolated into the fourth quarter.<\/span><\/p>\n .\u00a0<\/span> \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 Values are in Thousands\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0\u00a0<\/strong><\/span> Even with a banner year in 2021, operating margin at 11.89% is respectable but not at the standard McDonalds’ has set at 14.23%. This means that if Chipotle could perform at the standard McDonald’s has set, Chipotle’s operating profit would be around $1,059,995,000. After taxes and interest, Chipotle’s bottom line net profit could reach as much as $670,460,000 per year. Thus, with $7.5 Billion in sales, Chipotle could net as much as $700,000,000. This means the bottom line net profit is about 9.3% at optimal operations. This is important because this value is used in one of the intrinsic value formulas.<\/span><\/p>\n A third set of financial data important to determine intrinsic value is rooted in the balance sheet. This is a summary presentation of Chipotle Mexican Grill, Inc.’s balance sheet.<\/span><\/p>\n One of the interesting data points related to many fast-food restaurants is how lease obligations are always greater than the leased assets. This is not unusual, but it reflects how the lessor typically does site improvements that will go beyond the term of the lease but in effect, gets the tenant to pay for this in the lease negotiations. For Chipotle, leased assets are worth about $2.8 Billion at the end of 2020 and the corresponding lease obligation exceeds $3.1 Billion. This difference is customarily amortized out during the first seven to eleven years of a lease. In effect, Chipotle is paying more each month than what the asset that is booked is worth each month.<\/span><\/p>\n As Chipotle builds more restaurants, this long-term obligation will continue to grow.\u00a0<\/span><\/p>\n There is one really glaring value on this summary report. Shareholder’s equity is 33.7% of the assets. This is pretty strong for a company this size. The reason is simple, Chipotle Mexican Grill, Inc. pays no dividends. In its entire history, not once has it issued dividends. This is a very important point when it comes to value investing. Chipotle reinvests every dime it has made which accounts for the huge growth rate it has experienced over the last ten years. Since Chipotle’s business model does not include franchising like most other informal eating out (fast-food) operations, it must retain all earnings to fund the growth of company owned restaurants. Not one restaurant in its entire portfolio is a franchised eating establishment. Just like the net operating income value is used with some intrinsic value formulas, so too does this non-dividend status impact balance sheet based intrinsic value formulas.<\/span><\/span><\/p>\n The informal eating out industry (fast-food) adheres to a particular financial model for success. McDonald’s is the absolute standard bearer with this model. Simply put, the model has three segments. The first is the traditional corporate owned restaurants segment. In general, McDonalds has over 2,700 corporate owned establishments. This serves a dual purpose, the primary purpose is to act as the model of performance for the second segment, franchisees. Secondly, the corporate owned locations produce a profit. This segment generates an operating margin of more than 14% and once adjusted for interest and taxes, this segment easily contributes at least a 10% net profit in relation to this segment’s revenue.<\/span><\/p>\n The second segment is the real money producer for McDonalds as it is for other fast-food chains. Franchising is by far the most important financial segment of any well-run fast-food chain. In general, the corporate office charges a 4% franchise fee on every dollar of revenue the franchisee generates. There are costs to this franchise fee, mostly monitoring, compliance enforcement and general administration of the program. But overall, franchising generates operating margins that often exceed 45% for most corporations. McDonalds has over 36,000 franchised outlets. This single segment is what elevates the overall profit margin as whole for McDonalds. In general, McDonalds net profit is over 22% per year. This segment is the driving force of value for any fast-food chain.<\/span><\/p>\n Of the three segments of revenue customarily found with a chain of restaurants, Chipotle Mexican Grill, Inc. only operates the first segment. Thus, of the three segments noted above, the standard operating model known as corporate owned restaurants, which produces the lowest overall operating margin, is the ONLY segment Chipotle utilizes to generate sales. Take note, franchising utilizes others’ (franchisees) capital to construct\/equip and start-up a new restaurant. Chipotle must use its own capital to carry out the construction, equipping and initial start-up of a new restaurant. This model difference impacts the ability to truly grow at exceptional rates for extended periods of time.<\/span><\/p>\n Thus, at the industry level, Chipotle Mexican Grill, Inc. can not match what other similar operations can do with potential growth.<\/span><\/p>\n Within the corporate owned restaurant segment, Chipotle has trouble matching the industry standards too. Again, McDonalds has set the standard. Utilizing a vast supply chain, a marketing\/advertising program, strict conformance requirements and a deep management program, McDonalds has proven year in and year out that generating between 12 and 16% operating profit margins are expected. This includes this segment’s share of the overall corporate organization’s costs. Net profits from this segment are between 9 and 11% annually. On average over the last six years, Chipotle’s operating profit is a mere 7%. Only during this last year has Chipotle demonstrated dramatic improvement to the operating margin driven by economy of scale with sales. Just understand, one year of reasonable performance does not justify ‘irrational exuberance’.<\/span><\/p>\n One last area of industry standards that impacts value. Every company reports ‘risk factors’ in their annual reports. McDonalds’ risk factors are similar to Chipotle. They both mention the overall economy and how important it is that consumer demand impacts their ability to generate sales etc. But there are differences between the two operations. For example, McDonalds writes about their food supply chain and how they have management systems and a wide variety of suppliers. They are exposed to risk for certain products due to limited suppliers. In the end, McDonalds states that supply may ‘increase costs or reduce revenues’.<\/span><\/p>\n Whereas, when Chipotle Mexican Grill, Inc. writes about their supply chain risks, they state it as ‘… supply of ingredients could adversely affect our operating results’. Notice the difference in the language, in effect, the economy of scale and the long-term relationships McDonalds has developed limits their exposure to increased costs or reduction in sales. Chipotle Mexican Grill, Inc. uses stronger terms to indicate that issues within the supply chain can substantially impact the profit of the company.\u00a0<\/span><\/p>\n This example of risk comparison is just one of the many that the two entities face but, McDonalds has the upper hand. Other risk factors include:<\/span><\/p>\n With all of these, McDonalds has the upper hand due to experience, size and stable operations. Chipotle still has many more years of operations to gain the experiences necessary to control the associated risks and their costs.\u00a0<\/span><\/p>\n Thus, the ability of Chipotle to match the operating profit margin of other organizations is still several years away. Although improving, Chipotle’s risks will impact the ability to instantly match the operating profits of other large operations.<\/span><\/p>\n With the knowledge of both the financial performance and the industry’s standards of performance, a value investor can now determine intrinsic value<\/span><\/strong><\/a>.<\/span><\/p>\n There are about six popular intrinsic value formulas. Add to this another two dozen or so variations of those six and there are literally more than 30 intrinsic value formulas. They key to identifying intrinsic value is using reasonable data points, expectations and thoughts. A reader can visit the internet and request intrinsic value for Chipotle and get some crazy numbers. Go back to the purpose of intrinsic value, it is the amount a rational individual would pay to own the rights to the respective security. Thus, it is important to understand what a buyer of stock would receive in exchange to own a respective share of Chipotle Mexican Grill, Inc. As illustrated in all articles on this site related to intrinsic value; the intrinsic value formula outcomes are broken out into the three major groupings of balance sheet, income statement and cash flows.\u00a0<\/span><\/p>\n There are three ownership rights to any investment. The primary right is a return on one’s investment. With stock, this is characterized via dividends. Secondly, the owner has the right to vote their share to set the course of policies, management and directors. Lastly, an owner of stock has the right to sell the stock at any time in the future.\u00a0<\/span><\/p>\n To be clear here, only the last ownership right is what a value investor would receive for this investment. Chipotle pays NO DIVIDENDS whatsoever. Thus, there is no value tied to dividends. Secondly, ownership of a few hundred shares isn’t going to change the policies nor management style or even who directs the company. Thus, the only benefit is the right to sell the stock in the future. With Chipotle, the only financial gain is to buy the stock low and sell it high and earn a good gain from the interim holding period.\u00a0<\/span><\/p>\n This immediately eliminates one of the popular intrinsic value formulas, dividend yield<\/span><\/strong><\/a>.\u00a0<\/span><\/p>\n
\nVALUE<\/strong> = $10.57 times 18.5;<\/span>
\nVALUE<\/strong> = $195.55<\/span><\/p>\nChipotle Mexican Grill, Inc. – Core Financial Elements<\/span><\/strong><\/h2>\n
![\"Chipotle](\"https:\/\/businessecon.org\/wp-content\/uploads\/Chipotle-Food.jpg\")
With restaurants, an investor must remember the distinct business model (Lesson 19). Informal dining out (fast-food) operations are high volume, low margin models. Rarely does any single transaction exceed $30 as the final sales price. Furthermore, fast-food companies are highly competitive and as such, the consumer is price sensitive too. Thus, any ability to generate operating margins in excess of 16% are unrealistic. The key to financial success is volume. Each store must prepare as many orders as possible and maintain high levels of throughput<\/span><\/strong><\/a> in order to generate enough gross margin<\/span><\/strong><\/a> to cover the location’s occupancy and other traditional operating expenses.\u00a0<\/span><\/p>\n
\n2014\u00a0 \u00a0 \u00a0 \u00a0 $2,472,000\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 1,783<\/span>
\n2015\u00a0 \u00a0 \u00a0 \u00a0 $2,424,000\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 2,010<\/span>
\n2016\u00a0 \u00a0 \u00a0 \u00a0 $1,868,000\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 2,250\u00a0 *Sales drop dramatically due to E. Coli incident.<\/span>
\n2017\u00a0 \u00a0 \u00a0 \u00a0 $1,940,000\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 2,408<\/span>
\n2018\u00a0 \u00a0 \u00a0 \u00a0 $1,984,000\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 2,491<\/span>
\n2019\u00a0 \u00a0 \u00a0 \u00a0 $2,205,000\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 2,622<\/span>
\n2020\u00a0 \u00a0 \u00a0 \u00a0 $2,223,000\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 2,768<\/span><\/p>\n
\n\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0Sales<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0Operating Profit<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0Margin
\n<\/span><\/strong><\/span>2014\u00a0 \u00a0 \u00a0 \u00a0 $3,214,591\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$710,800\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a022.11%<\/span>
\n2015\u00a0 \u00a0 \u00a0 \u00a0 $4,108,269\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$763,589\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a018.59%<\/span>
\n2016\u00a0 \u00a0 \u00a0 \u00a0 $4,501,223\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$34,567\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a07.68%\u00a0 * E. Coli Issue<\/span>
\n2017\u00a0 \u00a0 \u00a0 \u00a0 $4,476,412\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$270,794\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a06.05%<\/span>
\n2018\u00a0 \u00a0 \u00a0 \u00a0 $4,860,626\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$258,368\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a05.32%<\/span>
\n2019\u00a0 \u00a0 \u00a0 \u00a0 $5,561,036\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$443,958\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a07.98%<\/span>
\n2020\u00a0 \u00a0 \u00a0 \u00a0 $5,920,545\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$290,164\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a04.90%
\n2021\u00a0 \u00a0 \u00a0 \u00a0 $7,450,173\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$886,327\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 11.89% *Estimated the 4th Qrt Results Based on 3rd Qrt Actuals<\/span><\/p>\n![\"Chipotle](\"https:\/\/businessecon.org\/wp-content\/uploads\/Summary-Balance-Sheet-Information.jpg\")
<\/span><\/p>\nChipotle Mexican Grill, Inc. – Value Points Within Its Industry<\/span><\/strong><\/h2>\n
![\"Chipotle](\"https:\/\/businessecon.org\/wp-content\/uploads\/Chipotle-Restaurant-Location.jpg\")
The third segment is really a real estate management operation. The idea is straight forward, the corporate office goes out and finds the ideal sites\/locations for future franchisees. The corporate office negotiates long-term leases for this land and gets the property prepped (zoning\/water\/sewage\/utilities\/access\/egress\/cleared\/site development) for the franchisee to build their restaurant. Then, they in turn lease this location to the franchisee. There is a significant markup in the difference between what the corporate office pays for the rights to the land and what they in turn charge the franchisee. Margins with this segment exceed 25% and often on some individual leases more than 50%. Although, not the driving force of absolute dollars contributed to the overall profit of the company, the real estate arm of a fast-food chain leverages up the overall profit of the company.<\/span><\/p>\n\n
Chipotle Mexican Grill, Inc. – Intrinsic Value of a Share of Stock<\/span><\/strong><\/h2>\n
Balance Sheet Based Intrinsic Value<\/span><\/strong><\/span><\/h3>\n