Does Chipotle Have Its Sights Set on the Pizza Business?

Chipotle has quietly entered the pizza business by buying a stake in Colorado-based upstart Pizzeria Locale, a pizza-store concept that shares a mission of quality food and interactive customer service. Should investors in the major pizza chains be worried?

Feb 14, 2014 at 7:00AM

Chipotle Mexican Grill (NYSE:CMG) has spent the past two decades building a dominant franchise in the quick-serve restaurant (QSR) category, with a current base of roughly 1,600 stores around the world. While that business is still growing at a double-digit clip, the company has been pursuing opportunities in other categories, including Asian cuisine through its six-store ShopHouse Southeast Asian Kitchen brand. 

Now, it appears that Chipotle has found an angle into the pizza business, recently investing in Pizzeria Locale, a Colorado-based QSR pizza concept that, like Chipotle, utilizes premium ingredients and an open, interactive store format. So, should investors in the pizza chains take notice?

Still a major force in quick serve
Despite remaining a major force in the QSR space, the pizza business has found greater sales hard to come by, reporting a 0.8% compound annual growth rate from 2002 to 2012. That being said, some proactive operators have used a greater online presence and evolving menus to drive higher traffic to their networks of stores.

Domino's Pizza (NYSE:DPZ), for one, has been riding a wave of positive momentum after shaking up its pizza recipe and store operations in 2008. The company has been actively bulking up its online capabilities by focusing its technology resources on mobile application development, an effort that allowed it to ring up $1.1 billion in online sales in its latest fiscal year. Domino's has also been expanding its international presence, the source of more than half of its overall sales, with a current operating footprint across 70 countries.

In FY 2013, Domino's has continued its favorable momentum, generating an 8.5% top-line gain thanks to increases in comparable-store sales and in the size of its global network of stores. The company's overwhelming use of the franchise model, accounting for 96% of its store base, has allowed Domino's to focus on big- picture areas, like creating more diversity in its menu. The net result of Domino's efforts has been consistent improvement in its operating profitability, thereby allowing it to make down payments on the large debt load incurred during its Bain Capital-led leveraged buyout in 2004.

Also doing well in the current environment is Papa John's International (NASDAQ:PZZA), a company that is living up to its name with a growing international segment that has current operations in approximately 40 countries. Like Domino's, Papa John's has used menu changes to drive an increase in customer volumes including newer complementary items like chicken poppers and Buffalo-style wings.

In FY 2013, Papa John's has reported a solid 7.8% top-line increase, aided by higher comparable-store sales, including a scorching 7.7% gain in its international segment. While Papa John's gross margin has been hurt by higher commodity costs, cost savings at the corporate level have allowed it to maintain a stable level of operating profitability and to fully fund its expansion activities with internally generated funds. As a result, Papa John's remains in growth mode, targeting further 30% growth in its worldwide store base over the next few years, with 1,300 stores in its development pipeline.

Will healthy pizza sell?
Part of the pizza industry's recent growth troubles is likely due to its core product's perception of being high on carbohydrates and low on nutritional value, a view that is corroborated by a quick glance at the Domino's Nutrition Guide. While the major pizza chains have tried to make their menus more appealing to a health-conscious crowd, primarily via better-quality ingredients, their core customer base likely makes purchase decisions based on impulse or taste rather than nutritional content.

Chipotle can certainly use its size and scale to build a profitable niche in the pizza quick-serve business, but it is not clear that Chipotle will enjoy stratospheric growth in the area akin to its trajectory in the chicken quick-serve segment.

The bottom line
Chipotle has its sights set on the pizza business and for good reason, given the $32.5 billion of pizza segment sales that were rung up in 2012. While the pizza chains should have their eye on the evolution of the nascent Pizzeria Locale concept, due to Chipotle's association, investors in the growing pizza chains shouldn't cash in their chips just yet.

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Robert Hanley owns shares in Domino's Pizza. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill and Papa John's International. 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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