In the book Algorithms to Live By, I was exposed to a concept that improved my ability to make decisions -- the "explore-exploit trade-off." I'll spare you the nerdy details. But I'm at the stage of life where I should be exploring things. Instead, I keep exploiting (ordering) the same chicken burrito from Chipotle Mexican Grill (CMG 0.44%) over and over because it's just so good. Why explore the menu further?
Chipotle does a good job making my burrito. But that's not the only thing this restaurant chain does well. The company has profit margins that are hard to comprehend, and it's incredibly material for investors making decisions about Chipotle stock today.
One of the most remarkable numbers I've ever seen
On April 24, Chipotle reported financial results for the first quarter of 2024. Keep in mind that there were nearly 3,500 company-owned locations at the end of the quarter. This is a huge chain, and it consequently has big corporate expenses outside of its restaurants. These are called general and administrative expenses, and they cost Chipotle over $200 million in Q1 alone.
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Key Data Points
These expenses are largely necessary, but they aren't core to running a restaurant. If you strip out these corporate costs for analysis purposes, you're left with the restaurant-level financials. And this is where Chipotle really shines.
In Q1, Chipotle had a restaurant-level operating-profit margin of 27.5%. Since the restaurant industry is notoriously a low-margin proposition, Chipotle's numbers are remarkable.
Chipotle's Q1 margin wasn't only good in comparison to other restaurants, it was also good in comparison to itself. Here's how the five most recent quarters have played out.
| Quarter | Q1 2023 | Q2 2023 | Q3 2023 | Q4 2023 | Q1 2024 |
|---|---|---|---|---|---|
| Restaurant-level operating margin | 25.6% | 27.5% | 26.3% | 25.4% | 27.5% |
Numbers from Chipotle's press releases. Table by author.
Right now Chipotle is hitting its best numbers in the past year, which is encouraging for shareholders. In fact, the company is actually hitting record high numbers that are night-and-day better than just five years ago. And the numbers were nothing to sneeze at back then.
Here's a table of Chipotle's numbers from five years ago, with the most recent quarter back in there again for comparison.
| Quarter | Q1 2018 | Q2 2018 | Q3 2018 | Q4 2018 | Q1 2024 |
|---|---|---|---|---|---|
| Restaurant-level operation margin | 19.5% | 19.7% | 18.7% | 17% | 27.5% |
Numbers from Chipotle's press releases. Table by author.
Looking at 2018 holistically, Chipotle had a restaurant-level operating margin of 18.7%, which in itself was a marked improvement from 2017. But even though it was already good back then, this profitability metric was 47% better in the most recent quarter, compared to what the company was capable of just five years ago.
Put another way, for every $1,000 in sales, Chipotle's restaurants made $187 profit in 2018. In comparison, in Q1, restaurants made $275 in profit for the same sales numbers. That might not seem like much of an improvement. But the company has nearly 3,500 locations and they do over $3 million in average annual sales, so it adds up.
What it means for investors
If Chipotle had only opened a lot of new restaurants over the years, it would have been a growth opportunity. But because it's been able to increase sales per location and consequently boost its restaurant-level profits, it's been an explosive growth opportunity. If you want to understand why Chipotle stock is up about 370% in only five years, look no further than its 400% gains in earnings per share (EPS).
I admit that I'm personally conflicted about the right takeaway here. On one hand, Chipotle is putting up remarkable profitability numbers and should be commended. On the other hand, I wonder how sustainable its current margins are. And if margins slip to more historical levels, then this stock could be stuck in neutral even if its revenue continues to climb.
In other words, future restaurant-level profitability will absolutely matter for Chipotle's shareholders because it affects overall profits.
Thinking longer-term, Chipotle aims to have 7,000 company-owned locations in the U.S., and it believes these can reach $4 million in annual sales volume. This would undoubtedly lead to good things for shareholders if the company can keep its profit margins up.
It's a tall task ahead for Chipotle -- when you already have the best margins in the business, it's hard to maintain those and even further improve. However, this company has silenced the doubters time and again during its nearly 20 years as a public company.
Therefore, it's probably better to give it the benefit of the doubt and believe it can continue crushing restaurant-level profitability.
