Chipotle: It's Caliente!

If you don't have a Chipotle (NYSE: CMG  ) Mexican quick-serve restaurant in your town, I'm sorry. I recently moved back to Greenville, South Carolina, a town sans Chipotle. I'm bummed, but I expect that one will be here soon.

Why my high hopes? Because Chipotle is growing fast right now. Sales grew 28% in the third quarter, as the company opened 30 new restaurants. Same-store sale increased an incredible 11.6%, compared with 11.5% last year. That's caliente!

Growth is important, but it's more important to have a good business. And that's the real story with Chipotle; that and its incredible carnitas burrito. ... Ahhhh, maybe I need to call the Greenville Chamber of Commerce and speed Chipotle's arrival.

As seen from the table below, the company's margins are expanding as it grows.

FY2004

FY2005

3Q 2006

2006 YTD

Operating Margin

1.7%

5.4%

8.5%

7.7%

Net Margin

1.3%

6%

5.6%

5.1%



That's an enviable position to have. Margins have slipped a bit year to date, but that's mainly because store opening expenses have increased, dropping margins by 80 basis points.

While it's nice to see margins (this quarter saw price increases, lower food costs, and increased efficiencies from scale) and profits expanding (EPS was up 90% this quarter), I also want to know if a company is generating cash. That doesn't seem to be a problem for Chipotle, as cash from operations has increased 40% during this fiscal year.

How can they generate so much cash? With incredible working capital management, as seen from its cash flow conversion cycle of negative 17 days. Yes, it collects cash 17 days before it pays its bills. Year-to-date, it's kept about four days of inventory in the system (because spoiled carnitas would be very, very bad for business) and one day of receivables. It averaged 22 days to pay its suppliers.

Compare these numbers to its former parent, McDonald's. In 2005, Mickey-D's carried four days of inventory, 14 days of receivables, and 18 days of payables. It looks like the student is doing a better job than the teacher. Companies that have excellent working capital management can make for great investments. Just look at how Dell (Nasdaq: DELL  ) and Wal-Mart (NYSE: WMT  ) used it to their advantage.

Let's get back to the growth story for a moment. Management expects to open 95-105 cash making machines -- I mean, restaurants -- next year, but it only expects 10% of them to open in new markets. If it's filling up existing markets with restaurants and still expanding same-store sales, this bodes well for the future. Growth won't last forever, but this data shows that the concept still has teeth.

So, to sum it up in one word: Wow! Perhaps I shouldn't be so surprised that the business is incredibly well run, given the fact that it sprung from the loins of McDonald's (NYSE: MCD  ) (the last part of the spinoff was completed last month). If you ever wanted to know how to run a restaurant and make a ton of money doing it, McDonald's would be a great mentor. So while I love the growth and the growth opportunities Chipotle has, I love its operations even more.

Vaya Chipotle!

For more musings on Mexican restaurants, check out:

Dell and Wal-Mart are Inside Value recommendations. Dell is also a Stock Advisor selection.

Retail editor and Inside Value team memberDavid Meierdoes not own shares in any of the companies mentioned. He is currently ranked 107 out of 12,000 investors in The Motley Fool's CAPS rating service. You can view his TMF profilehere. The Fool takes itsdisclosure policyvery seriously.


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