3 Questions That Chipotle Must Answer

It's been a good year for Chipotle, but to beat out competitors Panera Bread and Yum! Brands in 2014, it must first answer three questions.

Jan 5, 2014 at 8:00AM

Chipotle Mexican Grill (NYSE:CMG) is the gourmet fast-casual burrito maker from Denver that has taken the market by storm. After a year of tremendous growth, can Chipotle continue to avoid the pitfalls that have hit fast-casual competitor Panera Bread (NASDAQ:PNRA)? Or will price competition from Yum! Brands (NYSE:YUM) Taco Bell finally catch up to this growth stock?

Here are three questions that Chipotle must answer to remain a top stock in 2014. 

How many locations can it support?
One critical thing that we must remember is that Chipotle is a growth company, and it's priced for growth. The stock has doubled this year, it now trades at 50 times earnings and five times sales, and anything less than excellent performance will not do. 

Just look at Panera. It's growing, just not as fast due to service "bottlenecks" that couldn't meet growth, and the stock has dropped. Profit in its recent quarter rose 17%, but the overrall growth profile is slowing, and that's hurt the stock.

Chipotle has five-year EPS growth of more than 30%, revenue growth in excess of 20%, and its most recent quarter was an absolute blowout. What should we be watching to ensure that growth continues?

Here's the critical growth question that Chipotle must answer: How many locations can it support? With 1,500 restaurants already, the company needs to start thinking about how many new markets it can penetrate, both domestic and international. If Chipotle's new store count slows, even if the existing stores do well, growth won't be strong enough to support a higher stock price. 

How fast can Chipotle's other brand concepts grow?
If you're skeptical about Chipotle supporting 3,000 locations, or growing internationally, there still may be opportunity. Chipotle has two new brand concepts outside of its namesake: ShopHouse and, now, Pizzeria Locale. 

ShopHouse is an Asian concept that has been well received, but has relatively few locations: a few in California and a few in the Maryland/D.C. area. Pizzeria Locale has an interesting story behind it. Chipotle co-founder Steve Ells became an ardent fan and believes that Chipotle's business model will work for pizza. Chipotle is a minor shareholder in this Neapolitan pizza maker, but it has the option to become a full owner. 

Both of these businesses have the "Chipotle model" of quality food, being cooked quickly in front of customers at a reasonable price. Do you believe that this strategy will work for an Asian concept, and wood-fired pizzas? That's the question to ask yourself if you're expecting another leg to this growth story. 

At what point does price become an issue?
About 250 points ago, hedge-fund manager David Einhorn made a very public short call on Chipotle. His thesis was that he thought Yum! Brands' Taco Bell was going to offer competition through its "Cantina Bowl," and that Chipotle's high prices would lead customers to Taco Bell. 

Einhorn is a very smart guy, but the short was clearly ridiculous to anyone who has eaten at Chipotle or Taco Bell. Taco Bell is synonymous with cheap, guilty-pleasure junk food, and with the Doritos line of tacos, it has refocused its brand.

While Chipotle customers were never going to leave for Taco Bell, I do at least understand why Einhorn made the call. At some point, if Chipotle has to increase prices much more, price could become an issue. Chipotle customers go to their restaurants for quality; might they "upgrade" to upscale Mexican restaurants instead? Maybe.

It's all about the value proposition. Chipotle needs to retain quality while staying affordable enough to fend off higher-end Mexican restaurants. So far it's been able to do this, and my bet is it will continue to do so, but that's definitely something investors should keep an eye on. 

Foolish thought: Bet on Steve Ells
Chipotle is now in a tough spot, as investors are expecting perfection. There will surely be speed bumps ahead, but what gives me comfort is Steve Ells' track record of being in front of the consumer. Chipotle makes food that people love, and by listing the GMOs in their products and supporting local farmers, it's building loyalty and good will among its customers.

To execute from here, Chipotle needs to answer our three questions with action. Can the company control costs, support additional locations, and successfully grow new brands? Let's keep an eye on it, but with this innovative management team, I'm betting it can. 

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Fool contributor Adem Tahiri has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill and Panera Bread. The Motley Fool owns shares of Chipotle Mexican Grill and Panera Bread. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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