Summary
- F1Q2021 revenues of ~$1.74 billion missed analyst projections by ~$10 million.
- EPS of $4.45 missed consensus estimates by $0.42.
- Substantial gains in digital transactions over the quarter.
- We’re increasing our 1-year Price Target to $1,546/share from the prior $1,477/share. Reiterate Buy Rating.
Investment Conclusion
Driven in part by somewhat easier comparables (given that sales were decimated in March last year due to the pandemic), Chipotle Mexican Grill (CMG) posted strong F1Q2021 financial results. Revenues increased dramatically, and propelled by revenue leverage, margins across the board (particularly restaurant margins), expanded significantly, resulting in substantial improvement in annualized: earnings and operating cash flows for the period. Over the quarter, digital sales remained strong, the loyalty program expanded by ~1.5 million members, and two new menu items were introduced. In addition, in the U.S., the company opened 40 new restaurants. Moreover, it announced plans to further penetrate Canada, setting a target footprint of a few hundred stores in the geography.
Short-term, over the second quarter, we expect outstanding financial outcomes, driven in part by easy comparables, as results over the same quarter last year were the worst experienced during the pandemic. However, financial performance over the third quarter and fourth quarter, although boosted by the increase in mobility, opening of dining rooms, and new unit development, might come in relatively lighter, due to difficult comparables (as results over the same period during the prior year were excellent). In addition, the lifting of curbs on restaurants will undoubtedly significantly change the number of food options available to customers, a development that could disadvantage CMG. Nevertheless, the back half of the year will provide tentative trends on the organization’s post-pandemic organic growth possibilities.
Longer-term, based on new unit development, domestically, and in particular internationally (as it is highly under-represented in foreign locations), and growth in average units volumes, as CMG’s food with integrity and significant value proposition attracts new customers, we expect significantly higher retail sales. In addition, higher restaurant margins as a result of higher average unit volumes, and operating leverage due to economies of scale will flow through to the bottom line, boosting profits and cash flows significantly, in our judgement.
With a view to factor in additional growth related to improved business dynamics (due to the solid performance during the pandemic) and plans to expand the Canadian footprint by a few hundred stores, we’re updating our 10-year Discounted Cash Flow model for the company. We’re adjusting: our normalized 10-year revenue growth rate to 14% from the prior 13.5%, and the outstanding shares count to account for quarterly changes. Based on the updates, we arrive at our revised 1-year Price Target of $1546/share versus the prior $1477/share. Reiterate Buy Rating.
There is significant opportunity for upside in CMG shares, as our valuation factors in a global footprint of merely 6,250 stores and average unit volumes of $2.8 million, which we believe is conservative considering: the universal appeal of the firm’s menu offerings and the value proposition it offers customers. In addition, as the footprint expands beyond our 6,250 restaurants projection, margins across the business will expand accordingly, leading to higher: earnings and cash flows.
(Please go through our initiation report “Chipotle Mexican Grill: Turnaround Story With Substantial Growth Potential” and related notes for our long term opinion on the stock).
Key Takeaways From The Quarter
F1Q2021 Results Summary. For the quarter, CMG reported revenues ~$1.74 billion (+23.4% compared to F1Q2020) below analyst expectations of $1.75 billion, and earnings per share of $4.45 (+64.8% on a year over year basis) which missed consensus estimates of $4.87. Excluding extraordinary items, earnings per share would have been $5.36, representing an increase of 74% from F1Q2020. In addition, compared to the same quarter last year, same-store sales increased by 17.2% over the first quarter. Net income for the period was ~$127 million reflecting an increase of 66.4% over the previous year’s same quarter. Restaurant margins of 22.3% expanded by 470 bps on a year-over-year basis.
Digital Sales Solidify Long-Term Growth Driver Position. Over F1Q2021, digital sales fired on all cylinders, expanding 134% on a year-over-year basis to ~$870 million, that represented ~50% of total sales. The outperformance was fueled by significant uptrend in most of the key growth drivers of the segment. Given our view that consumers are likely to continue to lean on these elements for their CMG purchases beyond the pandemic, we believe digital revenues are sustainable at current levels. Our argument is propelled by business dynamics that surround these drivers of digital growth, which we analyze below.
1) Chipotlanes. Given that Chipotlane orders are order ahead and pick-up orders that can be placed only digitally, as the number of Chipotlanes increases, so will digital revenues. At the end of the first quarter, 196 of CMG’s total footprint of 2,803 restaurants were equipped with Chipotlanes. During the period, the company launched 40 new stores, 26 of which included Chipotlanes, accounting for 65% of the new units. Over FY2021, CMG has indicated plans to open 200 restaurants, 70% of which will be equipped with Chipotlanes. Given the new unit development dynamics, clearly significant digital sales related to the vertical are ahead.
2) Pick-Up Orders. These transactions are typically the order ahead type which most customers prefer to place through CMG’s: proprietary app or website. Given that the firm’s delivery orders are tagged with a significant surcharge, which has grown substantially over the recent months, the percentage of customers likely to place pick-up orders is likely to increase, in our assessment. The development will be favorable for CMG, as pick-up orders represent the highest margin transaction for the company. Over F1Q2021, digitally placed pick-up orders accounted for slightly more than 50% of digital sales.
3) Delivery Orders. These types of orders require digital order placement as most customers prefer paying for delivery transactions using debit cards or credit cards. Delivery orders are typically placed through: CMG’s proprietary app, the CMG website, or third party aggregators. During the first quarter, ~40% of all delivery orders were placed through the company’s platforms, while the remainder were processed through alternate delivery websites. We expect delivery orders to decline somewhat as pandemic conditions ease, over upcoming quarters.
4) Menu Offerings. On March 11, the firm launched its first new entrée in 17 years, quesadillas, which can be customized to customer preferences. The entrée planned as a permanent addition to CMG’s menu offerings, and introduced in the U.S. and Canada, appears to be highly popular, among regular customers and new customers, with an incident rate of ~10% since debut. Importantly, CMG’s quesadillas are a digital only menu item. In alternate terms, to purchase the item, customers are required to place orders through digital channels. In addition, given that the firm’s digital production lines have excess capacity, CMG might augment its digital only menu offerings, indicating incremental digital sales growth in the future.
5) Loyalty Program. CMG’s Rewards Program offers 10 points for every dollar spent at the company’s restaurants. The points can be exchanged for a free regular sized entrée once customers earn 1,250 points. In addition, CMG offers registered customers discounts on menu items and promotes menu offerings tailored to consumer preferences. Since transactions related to the royalty program are processed digitally and the number of digital customers has been growing exponentially over recent quarters, digital sales linked to the program are likely to keep growing. At the end of F1Q2021, CMG had more than 21 million reward members of which ~12.5 million were active customers.
Menu Innovation Drove Incremental Sales Upside. The company introduced Cauliflower Rice as a temporary menu item, scheduled to be available from its launch in early January through mid-May. In addition, quesadillas were introduced as a permanent entrée, on March 11. Based on customer reviews, Cauliflower Rice might not prove as popular CMG’s other menu bases such as Brown Rice and Cilantro Lime Rice. However, it might be advantageous as a low carbohydrate alternative for customers attempting to reduce calorie intake. The quesadillas were popular enough among customers with some complaining that the sides accompanying the item should be inside the dish. We believe, quesadillas will evidence growth in customer demand and expect adjustments to the item to suit consumer tastes. Overall, the new additions to the firm’s menu offerings added material sales growth over the first quarter.
Canadian Footprint Expansion. Driven by average unit volumes that are consistent with U.S. counterparts, CMG plans on accelerating new unit development in Canada. The company currently has 23 of its 40 international restaurants located in the geography and is targeting a footprint of a few hundred restaurants in the region. Over the next 12-months, it plans on adding a handful of stores in Canada, including a Chipotlane, in late Summer. Given that CMG’s latest restaurant in the country, located in Surrey, British Columbia, is experiencing strong customer demand, we’re upbeat about the company’s prospects in Canada. In addition, considering that the international opportunity is significant, we’re highly encouraged that CMG is finally paying attention to geographic diversification.
Guidance Appears Reasonable. Even if one were to disregard the initiatives CMG has taken to improve sales, simply based on increased mobility, F2Q2021 financial results are likely to be solid, as F2Q2020 represented the height of the pandemic, with companies across the U.S. reporting decimated sales figures. Nevertheless, the firm’s guidance for the second quarter appears accordingly solid. For the period, CMG expects same-store sales growth of between 20% to 30%, average unit volumes $2.4 million, and restaurant margins of ~24%.
Balance Sheet Remains Strong. At the end of F1Q2021, the company had a cash and cash equivalents balance of ~$1.2 billion and no long term debt on its balance sheet. CMG can borrow an additional $500 million to fund operations under a credit facility, it has available. Given its funding position, we believe that the company will handily maintain liquidity over the final few months of the pandemic.
Bottom Line
Given the levels at which CMG currently trades it might not appear so, but CMG remains in the early innings of its growth cycle. Considering that its product is easy to execute at scale and tastes great, customer demand will keep growing and profits will keep coming. It’s up to the firm to exploit these elements for massive returns by expanding the footprint domestically and internationally. That’s all it will take to grow revenues from $6 billion to $20 billion and beyond. CMG has reached that inflection point in its evolution where it has turned into a money making machine.