While the entire restaurant industry is suffering in 2020, Chipotle (NYSE:CMG) has seen tremendous growth in its business, with the stock up around 60% in the past 12 months. The market has rewarded the fast-casual Mexican chain because it is growing revenue and profits amid the difficult COVID-19 environment. Not many of its competitors can say the same. With all the moves the company is making, here's why investors should expect Chipotle to become a much larger business five years from now.
How Chipotle is navigating the pandemic
Same-store sales, the top metric owners use to evaluate location performance, were down 12.3% in August for chain restaurants in the United States. Chipotle's same-store sales were up 8.3% last quarter (July, August, and September), and executives actually said that August was the high point for growth during the period.
How has it done so well? Two words: digital infrastructure. Over the last five years, Chipotle has invested heavily in its mobile application, built a strong partnership with DoorDash for reliable delivery, and perfected its mobile pickup process. With this infrastructure in place, customers can switch from in-store to delivery or takeout meals without missing a beat. Digital sales (Chipotle's segment for delivery and pick-up orders) grew 202.5% and made up 48.8% of overall sales last quarter. That number will likely slow post-pandemic, but it shows that Chipotle has the infrastructure in place to please its customers with or without the pandemic.
Chipotle's operating margin did drop from 20.8% in Q3 2019 to 19.5% in Q3 2020, mainly because of COVID-related expenses and higher delivery costs. However, the company is offsetting these new expenses with menu price increases.
How Chipotle grows from here
The model for Chipotle to grow revenue over the next five years comes down to two variables: same-store sales and location growth.
Same-store sales (or comp sales), as mentioned above, are the revenue growth Chipotle is getting from locations that have been open for 12 months or more. The easiest way to grow comp sales is by raising menu prices, which Chipotle has done with no issues, even in 2020. In fact, it raised the price of delivery items by 9% this summer, with no signs of any customer backlash.
At the end of Q3, Chipotle had 2,710 restaurants across the world, mainly in the United States. It wants to open around 200 stores next year and thinks that it can eventually double its store count, but stated things could change in the short-term because of the pandemic. Doubling its store count may seem a bit audacious, but when you compare it to other popular chains like Subway or McDonald's (NYSE:MCD) (both with over 10,000 locations in the U.S. alone) the plans seem reasonable.
If Chipotle can sustain its mid-single-digit comp sales growth while it continues to add locations, investors will be happy with how the business performs over the next five years.
But what about the valuation?
If a business is firing on all cylinders, it typically means the stock trades at a premium valuation. Chipotle is no different.
The company has a market cap of around $35 billion but only generated $392 million in free cash flow in the past 12 months. That gives it a price-to-free-cash-flow (P/FCF) of 90 vs. the industry average of 26. Is Chipotle a good enough business to deserve this premium valuation? Maybe. But investors should always be aware of the price being paid to own a slice of a business, even one as high-quality as Chipotle.
Nevertheless, investors should feel confident that Chipotle will likely continue its strong business growth. Its steady earnings in spite of the pandemic, pricing power, and potential to double its locations mean Chipotle could enjoy five years of strong growth ahead.