3 Reasons Chipotle Mexican Grill’s Stock Could Rise

Chipotle restaurant in Woodley Park neighborhood of Washington, DC. Source: Chipotle

Over the past five years, Chipotle Mexican Grill's (CMG 0.40%) highly successful restaurant chain has propelled its stock to lofty new heights. For evidence, the chart below shows how its shares crushed the performance of the S&P 500 and some other well-known market beaters since 2009:

After such an incredible run, investors might be wondering whether this trailblazing burrito maker can keep cooking up such tasty results. Skeptics point out that its shares, which trade at roughly sixty times earnings following a blowout second quarter, are far from cheap.

But Chipotle's disproved the doubters before and I believe it can do so again. Here are three key reasons why this stock has room to run over the long haul.

1. Chipotle's restaurants cook up savory profits

Since Chipotle's humble beginnings in Denver, founder Steve Ells has been frank about what he's set out to do: Build an incredibly efficient restaurant chain that serves delicious food prepared with high-quality ingredients.

More than two decades later, Chipotle's applying this same formula as it expands around the country. It offers a limited menu, relatively small restaurants, but comparatively fast service, also known as "throughput."

So, despite the fact that Chipotle takes "no shortcuts" in food prep, speed is of the essence. A finely tuned operation keeps costs low, throughput high, and profit margins healthy.

A Chipotle burrito bowl with guacamole. Source: Chipotle.

At the restaurant level, my colleague Brian Hill estimates Chipotle achieves an operating profit margin of roughly 26.4%. This, in turn, generates a company-level operating margin of 16.1%, which compares favorably to an industry average of 13.2%.

Even more important, Chipotle gets the most bang for its buck as it expands its burrito empire. The company's return on assets has increased from 10.1% to 17.8% in five years, which is double the restaurant industry average of 8.9%.

In short, Chipotle puts the fast in fast casual. High throughput allows it to serve more customers with minimal overhead. As a result, meaty profit margins and steady expansion have lead to impressive bottom-line growth even at this stage in its life: Over the past five years, net income increased by 33% on average.

At Chipotle, the steak has yet to lose its sizzle.

2. A cult-like following gives Chipotle pricing power

Another crucial ingredient at Chipotle is pricing power. From the perspective of Warren Buffett, "The single most important decision in evaluating a business is pricing power." There's simply no other characteristic that carries the same weight.

So what is "pricing power" and can it even exist in the cutthroat restaurant business? With Chipotle in mind, here's the rub.

When a company has pricing power, it means it can pass along price increases on its products without losing customers to competitors. To do this, a restaurant like Chipotle has to create a reputable brand name and build a cult-like following around its Mexican fare.

Over time, Chipotle has done exactly that. As I've pointed out before, Chipotle is seeing increased foot traffic from all demographics, especially the teenage market. But what's surprising is that even the price-conscious teens did not balk when Chipotle raised menu prices for the first time in three years.

All told, the higher cost of Chipotle's ingredients compelled the company to hike prices to reflect an average increase of roughly 6.25%-6.5% during the second-quarter. The full effect of that price was felt across all of the restaurants for the entire month of July, and management provided indication that customers have taken it in stride.

Comparable store sales were up 17% during the quarter – an astounding increase for a relatively mature chain – and management felt confident enough to raise sales volumes for its new stores from an expected range of $1.6-$1.7 million to $1.7-$1.8 million per year.

From the perspective of an analyst from Miller Tabak, other fast food chains like McDonald's have become "hooked" on discounting their menu offerings to entice customers. Meanwhile, Chipotle's raising prices as needed and even boosting the outlook for its new, unproven stores. That's a pricing power trend that would make even Warren Buffett salivate.

3. The big picture isn't just the burrito

Finally, growth is very important to investors in Chipotle. For some, it's tempting to project that Chipotle's current growth trajectory can't continue for much longer. After all, it takes a lot more effort for a restaurant chain to double in size from 1,700 locations than it does from, say, 700.

This is true, particularly in a brick-and-mortar business. But investors should think about this stock in terms of holding at least 5 to 10 years. And right now, Chipotle is barely in the early stages of planting new seeds that will fuel long-term growth.

For instance, management sees Chipotle as much more than a Mexican restaurant chain and instead as a fast casual model that can be replicated with different cuisines. ShopHouse, Chipotle's Asian concept, is one of those concepts; Pizzeria Locale, a Neapolitan pizza joint Chipotle recently invested in, is another.

Restaurant signs for Chipotle's new Pizzeria Locale and ShopHouse. Source: Twitter/@PizzeriaLocale,Twitter/@ShopHouseTweets.

Right now, ShopHouse has 8 locations in two major cities, and Pizzeria Locale is about to have two in Colorado. But, most importantly, management is encouraged that both concepts are showing sales patterns similar to those witnessed at Chipotle during its early days. They, too, will have limited menus and assembly line counters aimed at getting customers their orders in the quickest manner possible.

Further, with less than 1,700 locations today, Chipotle's restaurant empire is a drop in the bucket next to major fast food chains. Yum! Brands, for example, is home to three major chains that make up a combined 18,000 U.S. restaurants. That's more than ten times Chipotle's footprint. McDonald's has eight times as many burger restaurants in America alone.

For now, burritos and bowls are Chipotle's bread-and-butter. But it should take no stretch of the imagination to see a similar idea with a slightly different flavor take off in the near future. Meanwhile, opportunity also presents itself across the pond, where it's also barely scratching the surface in terms of international expansion.

The takeaway for investors
Chipotle's not just building burritos anymore. It's building a well-run fast casual restaurant chain that offers its own take on Mexican, Thai, and Italian cuisine. Its simple menu, assembly line ordering process, and no-frills restaurants have attracted a devoted fan base that gives Chipotle some flexibility to raise prices without deterring customers.

With two proven co-CEOs in Steve Ells and Monty Moran at the helm, Chipotle's a long-term investment that still has room to grow.