Since going public in 2006, shares of restaurant company Chipotle Mexican Grill (CMG 6.33%) are up over 3,800%, making it one of the greatest restaurant stocks of all time. Since going public, Chipotle has opened many more restaurant locations, sales per location have soared, and profitability has consequently skyrocketed.
Investors shouldn't overlook Chipotle's annual sales per location, otherwise known as its "average unit volumes." Restaurants with high sales per location have a better chance at leveraging operating expenses to achieve better profitability than their peers.
This is why I've started to size up Chicago-based Portillo's (PTLO -0.33%) as a potential investment. It appears to have all of the ingredients of Chipotle's success, and its average unit volumes are approximately three times those of Chipotle.
Meet Portillo's
Considering that Portillo's initial public offering (IPO) was in October 2021, I'm admittedly late to the party. But I had refused to dedicate analytic energy to what I dismissively thought was just a hot-dog chain with visions of grandeur. However, two friends -- both Chicago natives -- provided me with passionate overviews of the brand. So I finally decided to take a closer look.
I'm glad I did. As Portillo's patrons will tell you, the restaurant sells more than Chicago-style hot dogs. It also serves Italian beef sandwiches, made-to-order salads (a nearly $1 million per restaurant per year business by itself), hamburgers, and other items like fries and milkshakes.
As of the end of 2022, there were only 72 Portillo's locations, all of which were company-owned and operated. Chipotle's nearly 3,200 locations are all company-owned as well. However, Portillo's relatively few locations pack a punch. On average, these restaurant locations generated $8.5 million in annual sales volume in 2022.
When it comes to average unit volumes in the fast-casual restaurant industry, Chipotle has long been the gold standard. Its volumes have increased consistently over the years, and in 2022, they surpassed $2.8 million. Therefore, as good as Chipotle is, Portillo's is roughly three times better in this one area.
As stated, high sales volume allows for better profit potential at the restaurant level. Unfortunately, Chipotle and Portillo's measure this different ways. Chipotle's restaurant-level operating margin was nearly 24% in 2022. Portillo's restaurant-level margin for adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) was almost 23%.
Portillo's preferred profit metric may adjust for more expenses than Chipotle's. But a 23% restaurant-level adjusted EBITDA margin is still stellar nonetheless.
Image source: Portillo's.
The Portillo's plan to create shareholder value
Portillo's has 72 locations today, but its research suggests it could operate more than 600 locations in the U.S. someday. Therefore, management intends to grow its restaurant count by about 10% annually. At that pace, it will take over 20 years to reach 600 locations.
Perhaps Portillo's management isn't opening new locations faster due to its rigid site-selection standards. According to commentary at the UBS Global Consumer and Retail Conference, CEO Michael Osanloo vets every new location that his team identifies by personally visiting the site himself.
Management has made three promises to investors, and Osanloo is looking for new locations that can deliver. First, each new location needs to have potential for $6 million in annual revenue by the third year of operations. Second, each market needs to support adjusted EBITDA margins in the mid-20s. And third, the cash-on-cash return needs to be about 25%.
Cash-on-cash return is a common real-estate investing metric. Basically, if Portillo's spends $1 million to construct and outfit a building, it wants to generate positive annual cash flow of $250,000. In this scenario, every new location pays for itself after four years. For what it's worth, 25% cash-on-cash returns are quite good.
Assuming Portillo's can open hundreds of restaurants with these kinds of numbers, it would be almost impossible to not create substantial shareholder value over the long term. And it would essentially be executing the exact same play book that Chipotle used as it delivered its market-crushing gains.
Moreover, trading at just 1.5 times trailing sales, Portillo's stock is also quite reasonably priced today.
The big question for shareholders, in my opinion, is whether Portillo's can extend beyond the Midwest and enjoy national, and even international, appeal. Regarding that question, there is encouraging data.
In recent years, Portillo's has opened 10 restaurants in California, Arizona, and Florida, and these are doing well. But to start 2023, the company opened its first Texas location. That one location is on pace to do $17 million in sales this year. Management expects volume to taper off as the year goes on. But this encouraging data point suggests Portillo's can expand outside its core market, giving it very promising long-term potential.
