On their quarterly conference calls, Chipotle Mexican Grill (NYSE:CMG) executives regularly talk about "opportunistically" repurchasing stock "to enhance shareholder value." Last week, Chipotle CFO Jack Hartung announced that Chipotle had repurchased nearly 4.2 million shares for $673 million over the course of its buyback program.
However, for the most part, Chipotle's buyback program has not returned cash to shareholders. Instead, almost all of Chipotle's buyback activity has been needed to offset its generous stock compensation.
Chipotle has matured to the point where it can easily finance its future growth from its cash flow while still leaving plenty of cash to distribute to shareholders. Accordingly, the company should increase its buyback activity in order to do more than just offset dilution from stock options.
Share count hasn't moved much
The main reason share buybacks can enhance shareholder value is that reducing the number of outstanding shares gives each remaining shareholder ownership of a greater percentage of the company. Yet while Chipotle has spent hundreds of millions of dollars in the last five years to buy back stock, these efforts haven't reduced its share count very much.
During 2006 -- Chipotle's first year as a public company -- the company's average diluted share count was 32.5 million shares. Chipotle's diluted share count peaked in 2007 and 2008 at 33.1 million. Since then, its average share count has remained in a fairly tight range of 31 million-32 million share (including the dilutive impact of outstanding stock options).
As of last quarter, Chipotle's diluted share count was right in the middle of this range at 31.5 million shares. Thus, Chipotle has bought back more than 4 million shares during the course of its ongoing repurchase plan, but the net reduction in its share count since 2006 has been much smaller: just under 1 million shares.
Stock options are the key
Stock options are the key cause of this discrepancy. Chipotle has awarded its management team generous stock-based compensation in the past few years to reward them for Chipotle's stellar performance.
Many people think Chipotle's stock compensation is too generous. Chipotle's co-CEOs are receiving pay packages worth about $25 million each, including the value of stock compensation. Shareholders overwhelmingly voted down a "say-on-pay" resolution earlier this year, registering opposition to this level of pay.
Given that Chipotle has been one of the most successful companies in the world in the past few years, I think Chipotle's top executives have earned their big pay packages. The real problem for shareholders is that Chipotle has barely been buying back enough stock to offset the dilution from these stock awards. Investors aren't being diluted, but Chipotle isn't really returning much cash to them, either.
Plenty of cash available
Chipotle regularly tells analysts that its primary priority in terms of capital allocation is investing in growth. This is thoroughly justified by Chipotle's high return on capital.
However, the beauty of Chipotle's business is that it can earn high margins and grow rapidly with relatively small capital investments. Through the first nine months of the year, Chipotle opened 132 restaurants, but only spent $160 million on CapEx. During this period, it generated $550 million of operating cash flow.
In other words, Chipotle can grow its restaurant count by 10%-15% annually while generating plenty of free cash flow. The result is that Chipotle has more than $1.2 billion in cash and investments sitting on its balance sheet. That's up from $836 million a year ago.
Since Chipotle generates free cash flow consistently, there's no reason for it to hold so much cash, which earns virtually no interest. Chipotle could safely return as much as $1 billion of its cash to investors through a bigger share repurchase program. That would allow it to finally make progress on reducing its share count.
The bottom line
Like many young growth companies, Chipotle has had a bias toward hoarding cash. However, Chipotle is maturing, and it now produces hundreds of millions of dollars of free cash flow each year -- while still growing.
It's time for Chipotle's management to open up the purse strings. While the company may not be ready for the long-term commitment of a quarterly dividend yet, it has as much as $1 billion of excess cash. By using excess cash to more aggressively repurchase stock in the future, Chipotle's management can further improve long-term shareholder value.