I live in Washington DC's northwest corridor, not terribly far from the city's culture center, DuPont Circle. The DuPont area is known primarily for two things. One, its massive rotary park that offers the neighborhood its namesake clustered with trees, scattered with park benches and punctuated by a picturesque fountain. And, two, the diverse cross section of people that call it home. Nestled in a cozy, low-rise storefront on the northern edge of the circle is Chipotle's (NYSE: CMG) pet project: ShopHouse.
Shop House is a commonly used architectural term in South East Asia for a row of single or multi-story storefronts used for both commercial and residential purposes. The architectural term has ties to 18th century colonialism, which explains its resemblance to the row house-style storefronts of Washington, DC. Shop Houses often serve as both restaurant and home, with proprietors living in apartments above their stores that serve rice, noodles and spiced meats. This is the name that Chipotle chose for its experimental move into Southeast Asian cuisine.
Stepping inside ShopHouse, you will notice immediate similarities to Chipotle's customary setup of its urban locations: small footprint, simple interior design, limited seating and assembly line-esque food delivery. The design allows for prompt food delivery during high volume flows of "rush hour" much in the same way Chipotle does. The items are fresh, organically sourced and, quite honestly, delicious. I have dined here a few times and it is clear that ShopHouse both underlines the successful strategy Chipotle has carved and defines a promising opportunity for US and international growth.
With its scale and efficiency, Chipotle has moved out of the niche Mexican inspired fast food market into the big leagues with juggernaut competitors Subway and Burger King (both privately held) as well McDonald's (NYSE: MCD), competing to a lesser extent with Taco Bell (NYSE: YUM), Qdoba and Moe's.
Financially the company continues to be strong. Last quarter Chipotle posted a 24% year over year revenue growth versus same period a year ago, had less than $4M in debt on the books and enjoyed a 15% operating margin. That margin is competitive with YUM's, but it is important to note that YUM also operates KFC, Long John Silvers and Pizza Hut. While McDonald's is able to enjoy a 30% operating margin, it is difficult for Chipotle to post such figures with organically sourced ingredients.
The success of Chipotle, due in large part to its ingredients and culture as part of its Food With Integrity mantra, indicates a shift in consumer preferences. McDonald's Smithfield Farms McRib debacle underlines what consumers have shifted away from. More and more people care about what they are eating and where it's sourced.
In the parlance of our times, Chipotle has four "bazookas" it can trigger to stimulate instant growth.
Major Television Ad Campaign
Chipotle has never had a major television ad campaign; instead it frequently turns to modest radio spots and, my personal favorite among promotional tools, market-area-centric BOGO (Buy One Get One free) coupons. The tangible effectiveness of advertising is a debate for the ages, and Chipotle has done a marvelous job gaining market share without it. But there is no doubt that if they want to replace their jabs at the major fast food market with haymakers that a television ad campaign would do the trick.
The second is franchising. Chipotle is a tightly managed restaurant with a very consistent product; a consumer knows when he walks into a Chipotle in Chicago that he will get the same quality burrito that she got in Boston. Franchising would strain management to maintain this same level of consistency, but could prove very lucrative. For example, just to consider franchising with McDonald's, a franchisee needs 25% of the new store value of non-borrowed money, typically a minimum of $250,000, as well as $500,000 more of non-borrowed money in the bank. After that there are monthly service fees and rent that are a percentage of monthly sales. The cash requirements take much of the risk out of selling franchises and the method outsources much of the cost to franchisees who have ¾ of a million of skin in the game to run their franchise effectively. There is no indication that Chipotle intends to exercise this option, but it remains an untapped opportunity.
Scanning the company's most recent SEC filings, ShopHouse is only mentioned twice, both times simply to acknowledge that the store had been opened. In an effort to gain further insight, I reached out to Chipotle Investor Relations, disclosed my humble post as a freelance blogger and asked for details on management's plans for ShopHouse. In just two days time I was given a reply from a Director of Investor Relations. Not bad for a company worth more than $10B. He let me know that management sees ShopHouse as a "seed" opportunity, using the DuPont Circle store as an exhaustive economic experiment of the concept's viability. He said his company has been pleased with the performance of the store and that the concept would likely be expanded upon in the near future, though no formal plan has yet been set. Will ShopHouse ever eclipse 1,100 stores like Chipotle? Probably not. The customer is a smaller subset of the fast food diners, but major expansion in diverse metropolitan locations is a viable opportunity.
Of its 1,169 stores, only four are outside of the United States. There is no question that international markets could offer major growth opportunities.
With a share price of $340 and a Forward P/E ratio of close to 40, it seems that analysts have priced in a lot of growth. I believe that Chipotle will take advantage of its opportunities and continue to outperform market expectations.