Chipotle (NYSE: CMG ) is on fire.
The company reported another great quarter with improvements on almost every metric. Revenue was up, margins expanded, and same-store sales improved. The only problem with this stock is the lofty valuation. The market capitalization is $1.7 billion, and that seems like a lot to pay for a chain of less than 600 burrito joints -- at least on the surface. However, the more I look at this company, the better it looks.
Recent performance has been outstanding. Over the last three quarters, the company has beaten average analyst EPS estimates by $0.05, $0.14, and $0.08 per share. On average, that's 60% better than expected. For a newly public company, it's an auspicious beginning. But for buy-and-hold investors, long-term performance of the business is more important than the results of any given quarter.
For those investors, here's the simple arithmetic of the bull case. The average unit volume at each store is very high, and the "restaurant level operating margin" (which includes food, drink, packaging, labor, and occupancy costs and is similar to gross margin) on those sales is very high. The company owns all but eight stores, so nearly all of the profit goes directly to the company instead of being spread among franchisees. And the company is also steadily expanding the number of stores.
The average unit volume at each Chipotle store is almost $1.5 million, which is significantly better than other fast-casual Mexican restaurants. According to sell-side analysts at AG Edwards, Wendy's (NYSE: WEN ) Baja Fresh chain and Jack in the Box's (NYSE: JBX ) Qdoba chain have average unit volumes of $1.2 million and $0.9 million, respectively.
For the first half of 2006, Chipotle's restaurant margin was 21%. In the first half of last year, it was 18.6%. Using an assumption of 20% for restaurant margins and an average unit volume of $1.5 million, I calculated that each store generates about $300,000 a year in gross profit. Since the stores are company owned, all of that money goes to the corporate coffers in Denver.
Chipotle had almost 500 stores at the end of 2005, and 80 to 90 new stores are planned for this year. Assuming an average of 540 stores in 2006, the company's restaurants could produce $162 million in gross profit. Of course, that's not net profit. The company still needs to take out corporate overhead, taxes, and non-cash charges for depreciation and amortization. However, even after those deductions, the company is still turning a tidy profit -- $19 million in the first half of the year.
However, the best part is that the company reinvests those profits in new stores, and Chipotle's return on invested capital has been increasing as new stores open. Considering that the company has a clear growth trajectory, continually improving operations, and the ability to reinvest profits at a high rate of return, it may be worth paying up for this stock.
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