Chipotle Could Potentially Become Alot Bigger

Source: Chipotle

J.P. Morgan Equity Analyst John Ivankoe called Chipotle Mexican Grill  (NYSE: CMG  ) a "once-in-a-decade" type of brand following its blowout second-quarter earnings report, which sent shares soaring higher. However, looking beyond the second quarter and 2014 guidance, is Chipotle really on pace to become an iconic brand? To answer that question, what better comparison is there in the restaurant space than McDonald's (NYSE: MCD  ) , a company that too has changed the restaurant game during its storied history?

Once-in-a-decade brand
It has been a long time since investors have seen a company grow like Chipotle. Sure, we've seen 28.6% revenue growth and same-store sales increases of 17.3%, but normally it occurs with much smaller restaurants, or those with room to expand rapidly. Furthermore, it has been decades since we last saw a restaurant grow at a double-digit rate with quarterly revenue in excess of $1 billion.

In fact, not since McDonald's early days have we seen growth like this. Regardless of what you think of the company today, McDonald's is a company that transformed restaurants with the fast-food concept. Over a 50-year period, McDonald's has become the largest restaurant in the world, with 12-month revenue of $28 billion thanks to its game-changing entry into the restaurant space.

With that said, we can conclude that McDonald's was in fact a "once-in-a-decade" brand, and while growth has stalled today, the company's history is filled with double-digit growth and rapid expansion. Therefore, how can we determine if Chipotle is the next McDonald's?

The next McDonald's
To answer that question, we must compare fundamentals. Now clearly it wouldn't be fair to compare two companies that are completely different sizes. However, if we look back at a time when McDonald's was of similar size to Chipotle and compare growth rates, it would give us an idea of how Chipotle measures against the largest and most dominant restaurant in history. Consequently, we'll see if Chipotle is on track, exceeding, or lagging McDonald's at similar periods of company size.

So, let's go back to 1985, the third quarter, as McDonald's posted revenue of $1.01 billion and net income of $128 million. On a year-over-year basis, McDonald's grew revenue and net income by 10% and 12%, respectively, with a profit margin of 12.6%. If we look further ahead, McDonald's then grew revenue and net income by 7.9% and 9.4%, respectively, on a 10-year annualized rate ending in the year 2000; the company's annual revenue had grown to $14.2 billion by 2000.

Therefore, McDonald's growth was slow and steady but was also driven by global expansion, as it grew to 35,000 stores plus. Meanwhile, Chipotle has just 1,681 stores, meaning it has a long way to go before catching McDonald's.

This is very telling
Nonetheless, based on McDonald's growth in 1985, and what it has become, we can conclude that Chipotle might not be a once-in-a-decade restaurant but perhaps the first of its kind. McDonald's growth proves that we have never seen growth of Chipotle's magnitude, especially once a restaurant surpasses the $1 billion in quarterly revenue mark.

Chipotle's near 29% growth in the second quarter is nearly three-times greater than McDonald's at similar points in each company's business cycle. For investors, this should be very telling for those who consider Chipotle's $20 billion market capitalization to be expensive, as it indicates that the long-term upside in Chipotle shares might be far beyond its current valuation.

Something to consider
A key fundamental observation that many investors might miss is the consumer expectations surrounding both McDonald's and Chipotle. Specifically, McDonald's has remained competitive by lowering prices and keeping value products intact despite rising food costs.

Meanwhile, Chipotle is known for quality rather than quantity and was thereby able to raise menu prices at an average of 6.25% to 6.5% during the second quarter. This is a feat that McDonald's has found very difficult, if not impossible, yet Chipotle has done so without missing a beat.

Final thoughts
Chipotle has the pricing power, consumer appeal, and historic growth on its side in becoming a "once-in-a-decade brand, if not a once-in-a-lifetime company in the restaurant industry. With all things considered, it would be tough to bet against Chipotle becoming the next McDonald's or bigger.

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  • Report this Comment On July 27, 2014, at 6:28 PM, CalvNHobbes wrote:

    Some apt history from a cousin of Chipotle, including a past association with McDonalds:


    By the spring of 1997, the company had over 1,100 restaurants and over $1 billion in annual sales. But the attempt to expand into the international market stretched it too thin, and a great deal of debt was raised to finance this. In October 1998, the company filed for Chapter 11 bankruptcy, and nearly 400 stores would be closed. In May 2000, McDonald's bought Boston Market for $173 million.

    With the McDonald's business team behind it, Boston Market was able to rebound, and had begun to sell some of its items as frozen food packages in supermarkets, seemingly a contradiction of the original owners' message. In 2007, with the number of restaurants stabilized at over 500, McDonald's sold the company to Sun Capital Partners.


    So take a careful look before you leap onto a "hot" restaurant property. Today's hit restaurant is tomorrow's used-to-go-there restaurant.

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Brian Nichols

Brian Nichols is the author of "5 Simple Steps to Find the Next Top-Performing Stock: How to Identify Investments that Can Double Quickly for Personal Success (2014)" and "Taking Charge With Value Investing (McGraw-Hill, 2013)". Brian is a value investor, but emphasizes psychology in his analysis. Brian studied psychology in undergrad, and uses his experience to find illogical value in the market. Brian covers technology and consumer goods for Motley Fool. Brian also updates all of his new and current positions in his Motley Fool CAPs page. Follow Brian on Twitter and like his page on Facebook for investment conversations and recent stories.

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8/28/2015 4:00 PM
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