Warren Buffett is no stranger to the restaurant industry, as his previous investment in Restaurant Brands International certainly shows. Although the company he heads, Berkshire Hathaway, exited this position last year, there are still attractive restaurant stocks that meet Buffett's criteria.
One in particular is Chipotle Mexican Grill (NYSE:CMG), which just reported another fantastic quarter on July 20th. In addition to having a powerful and well-recognized brand, the fast-casual pioneer delivers a great customer experience. What's more, the company has the ability to consistently raise prices over time.
These are characteristics that would definitely attract the attention of Warren Buffett.
A powerful brand
With a total of 2,853 locations as of June 30, it's no doubt that Chipotle is a popular name in the restaurant world. The business was the first to successfully launch and scale a fast-casual concept, which has since been imitated by many other restaurants. Chipotle's brand is so strong that new chains following a similar ordering process are often referred to as the "Chipotle of [name a cuisine]."
This mindshare is crucial to Chipotle's success -- it results in the company's famous burritos and bowls being a top choice for hungry customers. Even during the pandemic, which devastated most of the industry, Chipotle thrived. Comparable-store sales (or comps) in each of the last four quarters grew no less than 5.7%, with double-digit gains registered in the first and second quarters of this year.
Having a strong brand can benefit a business for a very long time, as Buffett knows well. Chipotle is currently experiencing just that.
A focus on the customer
Chipotle's leading digital infrastructure lets the company connect in more ways with its customers. In the most recent quarter, sales from the company's website, mobile app, and third-party delivery services accounted for almost half of total revenue. Furthermore, 45 of the 56 new restaurants opened in the quarter included a drive-thru, called the Chipotlane, to further provide a seamless ordering experience.
The chain's rewards program, launched in 2019, now boasts more than 23 million members. This provides an extremely valuable avenue to drive higher engagement and more-frequent restaurant visits from loyal customers. Chipotle occasionally offers up free guacamole or queso to rewards members, and communicates about new menu items, such as the quesadilla launched in March.
"Don't just satisfy your customers, delight them," as Buffett believes. Being able to engage more with customers allows Chipotle to serve them in convenient ways, providing a great guest experience. The nonagenarian investor would certainly approve.
The ability to raise prices
In Buffett's opinion, the best businesses are those with pricing power. This is beneficial because a company can raise revenue with no effort, and it all flows to the bottom line as profit. Only organizations that deliver more value to customers than they charge for, like Chipotle, can do this.
Following an increase in the average hourly rate for store employees to $15 in June, Chipotle raised menu prices by up to 4%. But this had no negative effect on the second quarter's performance. Revenue soared 38.7% from the prior-year period, and its restaurant-level operating margin of 24.5% was its highest in almost six years.
"Consistent with the past, we saw very little resistance with the price increase in any of these channels," CEO Brian Niccol said on the earnings call. "And I would tell you the good news is I think our value proposition remains very strong."
From a consumer perspective, it's hard to argue with him. Chipotle offers one of the best combinations of quality and value around, supporting future price increases.
What Buffett wouldn't love
The qualitative factors I discussed above align with Buffett's criteria for an outstanding business. The issue with Chipotle, however, is its current valuation.
Trading at a steep 72 times forward earnings, the stock has tons of optimism priced in. Therefore, investing with a margin of safety, something Buffett advocates, isn't possible at today's price.
Regardless of the positive fundamental traits mentioned for the company, it's best to wait for a pullback before taking a bite out of Chipotle.