Chipotle Mexican Grill (NYSE:CMG) is the quintessential fast-casual restaurant; it is the company that started the trend of quality food in a fast-paced environment. And while investors continuously seek the next Chipotle in established companies like Panera Bread (NASDAQ:PNRA) and smaller names such as Noodles & Company (NASDAQ:NDLS), there is one thing that separates Chipotle from the pack and explains why it's worth the premium.
What's most important for restaurant longevity?
In a couple short paragraphs, I am going to tell you what's most important when investing in restaurants and how to know when a restaurant is on the up or the fundamental down. This one metric ties to everything, whether it's good or bad, and is the quintessential metric to follow in this space.
With all suspense aside, we're talking about comparable-store sales! In restaurants of all sizes, companies can always expand with new locations, which in turn drives revenue higher. But, comparable-sales growth differs because it's the performance of stores that have been in place for at least 12 months.
Theoretically, if an existing store drives higher revenue over a 12-month period, it means more customers in the door or higher check averages. If basic costs such as property, utilities, and wages stay the same, then more customers and revenue per store translate into higher profits. Then, food costs are the only wildcard to affect margins. For companies that are simply adding new stores to create growth, we often see profit margin weakness, as it costs money to open new stores and for them to become established.
Therefore, companies with strong comparable stores are creating more revenue per square foot, which in turn creates higher profits, margins, and drives both top- and bottom-line growth. As a result, for a company to become massive, expansion can only take them so far. Eventually, a company needs comparable-store sales growth to drive profits higher, expand faster, and accumulate cash at a greater rate.
Here's the proof
With all things considered, you should now realize why comparable-sales growth is important and also what its performance can tell you about a company. But, for further proof that comparable-store sales directly impact a business as a whole, just look at the earnings report for top fast-casual restaurants in a very tough first quarter of 2014.
As for the standard of perfection, Chipotle grew its overall revenue by 24.4% in the first quarter, despite the rough winter storms throughout the country. While some of this growth came from expansion, the company saw a whopping 13.4% increase in comparable-store sales.
With that said, there are always unexpected events for restaurants and the uncertainty surrounding food costs. Specifically, Chipotle saw food costs rise an unprecedented 150 basis points due to the boost in guacamole costs, which should have crippled margins. Yet, because of its explosive comparable-sales growth, the company's operating margin declined just 40 basis points to an impressive 25.9%, both of which were unseen by the company's peers.
Panera Bread is also a large fast-casual restaurant, but with its first quarter, we can see a true disconnect between it and Chipotle. Specifically, its revenue increased 7.7% in the period, which isn't bad, but its comparable growth was flat, meaning growth came from new stores. Therefore, its operating margin declined 250 basis points to just 11.1%, with the latter number being less than half of Chipotle's margin. So, despite 7.7% revenue growth, increased costs associated with new stores and no improvement to existing stores equaled a 12% decline in net income.
Then, there's Noodles, a company that some believed could become the next Chipotle. However, its recent quarterly report insinuates that top-line growth is only an outcome of expansion and being small rather than a true movement of consumers inside its stores.
Specifically, its revenue jumped 10% to $89.5 million, but its comparable-store sales fell 1.6%. As a result, the company saw its operating margin fall 130 basis points to 17.3%. Granted, 17.3% is high; although analysts have noted in the past that with the company's main product being noodles, its margins are naturally high and are expected to grow significantly as the company grows. However, unless it begins to drive more consumers into existing stores, this is a company that'll have a hard to time producing the margin growth sought by Wall Street.
Despite being the largest fast-casual chain and selling high-cost products such as beef, chicken, steak, and guacamole, Chipotle is not only growing the fastest but also has the highest margins. This incredible performance can be directly tied to its ability to drive more consumers into existing stores and its revenue per store being double that of its next closest competitor.
Therefore, at 31 times next year's earnings, Chipotle is a bit pricey. But after a 20% decline from its 2014 stock highs, Chipotle is cheaper than it has been in quite some time relative to fundamentals. Hence, given its efficiency, and no signs of slowing down, Chipotle is worthy of its premium, or far more attractive than a slower growing Panera or Noodles at 20.5 and 54 times forward earnings, respectively.
3 stocks to own for the rest of your life
As every savvy investor knows, Warren Buffett didn't make billions by betting on half-baked stocks. He isolated his best few ideas, bet big, and rode them to riches, hardly ever selling. You deserve the same. That's why our CEO, legendary investor Tom Gardner, has permitted us to reveal The Motley Fool's 3 Stocks to Own Forever. These picks are free today! Just click here now to uncover the three companies we love.
Brian Nichols owns shares of Chipotle Mexican Grill. 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.