What's Chipotle's Secret Sauce?

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Shares of Chipotle Mexican Grill (NYSE: CMG  ) are up around 60% over the past year and up almost 250% since the company went public in 2006. So what's the key to Chipotle's success, and what will be its next big moneymaker? I recently asked Motley Fool Hidden Gems co-advisor and Stock Advisor associate advisor Andy Cross.

Mac Greer: What's Chipotle's secret sauce?

Andy Cross: Well, I think there are two aspects to the Chipotle experience. One is their "Food With Integrity." That's their phrase. It's essentially serving sustainably raised meats and ingredients that are healthy and as natural as possible. You don't find that in many fast-food places. Second, Chipotle is a very efficient operation from the time you walk in to a store until you receive your food. It's almost like Henry Ford's conveyor belt system. You go through the line quickly and customize your order, but it's also very high-quality food. They don't skimp. You're in and out and they can churn more and more customers through each store. That means more profits for shareholders.

Greer: OK, Andy. Let's talk efficiency.  I remember an interview we did with Chipotle's leadership a few years ago. They emphasized that the line at a Chipotle should always be moving and that you shouldn't have time to lean against anything. So how are they doing according to their "no lean rule?"

Cross: I don't know if Steve Ells, the founder and co-CEO, publishes a goal of how fast a customer should be in and out. But certainly less leaning means more eating. And that's good for stock owners. When Steve spoke to our colleagues at Million Dollar Portfolio in late 2008, he quoted 300 transactions per hour at some of their highest-volume restaurants. That's a lot of burritos, happy customers, and plenty of profits. And you see the food made right in front of your eyes, not way in the back behind the ovens. I like that.

Greer: And same-store sales are up.

Cross: They are humming, for sure. Same-store sales, a key metric in the restaurant business, were up almost 9% during the recent quarter, driving sales growth of 20%. Store profit margins increased, too, driving earnings growth of more than 31%. It's hard to argue with these kinds of numbers.

Greer: Speaking of numbers, which two do you look most to measure their success?

Cross: Well, same-store sales, obviously, is a big one, along with store profit margins. As I mentioned, both did well last quarter. Chipotle has just started some international growth opportunities, so we will see how that goes. They have opened a store in London this year and are now opening a store somewhere in France. They just passed 1,000 stores here in the U.S., a pretty big milestone. One thing to watch will be the expansion of their A Model locations. These are smaller locations with lower opening and operating costs. They have 10 of these in place now, so I'll be watching how fast they grow and what kind of per store sales and profits they ring up.

Greer: Chipotle has a pretty rich valuation relative to other solid food chains such as McDonald's (NYSE: MCD  ) , Starbucks (Nasdaq: SBUX  ) , Panera (Nasdaq: PNRA  ) , and Buffalo Wild Wings (Nasdaq: BWLD  ) . Each of those companies offers investors a compelling growth prospect, too. Do you think Chipotle is overvalued?

Cross: Tough one, Mac. We own shares at Hidden Gems, but we're not buying any above $150. But we're not selling, either. It's tough to tag a precise valuation on this fast-growing, very well-run company that consistently outperforms expectations. There is still a lot of room in that space, and they have just touched internationally, so they still think they can go to more than 3,000 stores. And with the smaller, more efficient A Model stores they are targeting markets that they before would have avoided. So if they can get those moving, that is a whole new marketplace for them. So far they haven't disappointed, so we're willing to give them, and the stock, room to run for now.

Andy Cross owns shares of Buffalo Wild Wings. Mac Greer doesn't own any of the stocks discussed. Chipotle is a Motley Fool Rule Breakers choice. Starbucks is a Stock Advisor selection. Buffalo Wild Wings and Chipotle are Motley Fool Hidden Gems selections. The Fool owns shares of Chipotle. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.

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  • Report this Comment On August 11, 2010, at 8:16 AM, scs660 wrote:

    Another key that helps them is thier narrow menu. Not having to spend money on a wide range of meats, sauces, etc not only makes for easy inventories but I also do not have to wait behind someone who can't make up thier mind while they look at the menu.

  • Report this Comment On September 17, 2010, at 2:35 PM, dlneff wrote:

    I noticed recently that one of the Boulder, CO, locations is offering beer and margaritas on the menu. Is this a test for a possible expansion to the rest of their locations? And what effect would it have on CMG if they begin to serve alcohol at, what is essentially, a high end fast food joint?

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