COVID-19 and the ensuing economic lockdown it sparked have put new life into grocery stores and eating at home. But to save their businesses, many restaurants have had to quickly pivot to online ordering and delivery -- further reducing profitability in an already thin-margin business and adding a new layer of operational complexity.

Chipotle Mexican Grill (CMG -2.57%) is far more fortunate than most, as it has already returned to growth mode, thanks in no small part to its digital ordering applications and delivery partnerships. A new standard is being created for the industry.

a product image shows a Chipotle burrito bowl with a side of chips and queso sitting on a serving tray

Image source: Chipotle.

Good quarterly results, considering

Chipotle notched a 14% year-over-year revenue gain in the third quarter to $1.58 billion. Comparable store sales (an average of the number of guests and order size) increased 8.3% even though the effects from the pandemic persisted. The reason for Chipotle's outsized success compared to others in the industry?  

Chipotle started investing in digital sales and delivery long before COVID-19 was on anyone's radar. Having those pieces in place was prescient headed into 2020. CEO Brian Niccol said that even as the economy has loosened up again, Chipotle has held onto 80% to 85% of digital sales -- even as its in-store activity has recovered 50% to 55%. The result, as Niccol expounded during the conference call:

"Q3 digital sales grew 202% year-over-year to $776 million and represented 49% of sales. Assuming this momentum continues in Q4, we believe digital sales could exceed $2.5 billion in 2020, more than double what we did last year. At this sales rate, our average restaurant delivers a digital [average unit volume] of well over $1 million, up from just a few hundred thousand dollars per restaurant a few years ago. During the quarter, about half of the digital sales came via the delivery channel with the remainder coming from order ahead and pickup transactions. Both channels continue to grow nicely with delivery benefiting from our expanded partnerships. Order ahead also remains robust as guests better understand the value offered by this channel as well as the convenience of more Chipotles, which provide an extraordinarily fast experience."  

Put simply, betting heavy on restaurant tech presents a big opportunity for businesses in this space -- or, in Chipotle's case, is the key to maintaining its growth trajectory as a new digital era dawns. With half of revenue derived from digital channels, perhaps it's time to adapt Domino's Pizza's (DPZ 0.18%) "a tech company that sells pizza" moniker to Chipotle as well: "A tech company that sells burritos."

How high-tech can it go?

But it won't be smooth sailing. Digital is helping sales advance this year, but not the bottom line. Higher fees paid to delivery partners meant lower restaurant-level operating margin of 19.5%, compared to 20.8% last year for Chipotle in Q3. The solution, for now, is to test higher delivery fees to help offset the higher expenses the company is incurring.  

Longer-term, perhaps the better option is to take a cue from Domino's, which controls its own delivery network rather than farming it out. As a result of the pizza king's dominance in this space, it turns a profit running pizzas around neighborhoods, and has generated rising free cash flow (revenue less cash operating and capital expenses) this year. Specifically, free cash flow was $319 million on revenue of $2.76 billion through the first nine months of 2020, good for a free cash flow margin of 11.6%. That's an enviable rate of cash generation in a notoriously competitive industry dominated by low- to mid-single-digit percentage profits.  

By comparison, Chipotle generated free cash flow of $549 million on revenue of $4.38 billion the first nine months of the year, a margin of 12.5%. Perhaps making deliveries directly isn't what Chipotle wants to do, but for a company with a massive scale (over 2,700 locations) and with delivery comprising some one-quarter of sales, I think making a change should be discussed (and probably behind the scenes already is). Not having to pay third-party delivery apps could certainly rekindle some profit growth and make Chipotle an even more valuable business down the road.  

For many industries, digital transformation means a leaner operation and higher profit margins. For many restaurants, though, it's about holding onto what they already have more than making any growth or profit expansion headway. But in this arena, Chipotle has served itself well by spending on the right technology ahead of the curve. Challenges remain, especially for the stock itself, as it currently trades for a whopping 97 times trailing 12-month free cash flow -- pricing it much more like a tech company than a restaurant. But I wouldn't be surprised to see Chipotle make some back-end operational changes to take advantage of its suddenly burgeoning digital business.