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Forget Share Buybacks: 3 Ways Chipotle Mexican Grill Inc. Should Invest Its $251 Million Cash Reserve

By Palbir Nijjar - May 5, 2016 at 1:29PM

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Buying back shares and opening over 220 new restaurants are not enough to turn the tide for this troubled burrito maker.

Revenue at Chipotle Mexican Grill (CMG 1.48%) fell 23.4% year-over-year during the first quarter, while same-store sales decreased 29.7%. As a result, restaurant-level operating margins took a major hit, shrinking from 27.5% in the year-ago period to just 6.8%. To top it all off, the company recorded a loss of $0.88 per share.

Even with those disappointing results, the burrito maker is looking to open 220 to 235 new restaurants this year, on pace with the number of new store openings in 2015. Management is also hoping to appease uneasy investors with share repurchases. The company has bought back over $900 million worth of common stock, or 1.87 million shares, since the foodborne-illness scares hit the company last summer, reducing the company's total share count by over 6%.

Share buybacks may signal to shareholders that management is bullish on the company's propsects, but signaling this confidence to the diners themselves is far more important. With few encouraging signs that hungry customers are returning to its restaurants, Chipotle would be better off spending its $251 million in cash elsewhere.

Expand noodles, pizza, and burger concepts

Image source: ShopHouse Kitchen

It was in 2011 that Chipotle opened its first ShopHouse Kitchen restaurant in Washington, D.C. The Asian-themed concept had the same industrial look and feel as Chipotle with orders customized at the counter. Five years after its first restaurant, ShopHouse has expanded to just 14 locations in four states.

Also in 2011, Chipotle partnered with two restaurateurs on Pizzeria Locale, a fast casual pizza restaurant. The partnership was kept under wraps for over two years to develop the concept. Today, Pizzeria Locale has just seven locations in three states. Despite these slow expansion efforts, Chipotle recently filed a trademark application for the term "Better Burger".

Before suffering a nearly 50% drop in its share price, a notable chunk of Chipotle's valuation was based on the potential growth of its other restaurant concepts. Now seems to be as good a time as ever to aggressively pursue their expansion.

Faster service
Before losing customers' trust, the biggest challenge at Chipotle restaurants was throughput. The company keenly focused on speeding up service during the lunch and dinner rush. Despite its efforts, the company was losing customers who saw long lines and chose to dine elsewhere.

Long lines are a problem the burrito maker would love to deal with again, and now is the ideal time to prepare for better throughput when customers eventually return for their burrito bowls and fresh guacamole.

Fast casual competitor Panera Bread (PNRA) was able to deliver faster order times and higher customer satisfaction with Panera 2.0. Online ordering, mobile-to-table delivery, and ordering through dedicated kiosks were all part of the initiative. As of year-end 2015, Panera 2.0 has been implemented in 410 restaurants. Same-store sales increased an impressive 7.6% at company-owned restaurants with Panera 2.0 upgrades, far outpacing the 3.6% comps growth for all company-owned locations.

That momentum carried into the most recent quarter. Although the company did not break out comps for converted cafes in the first quarter, overall same-store sales at company-owned restaurants increased 6.2%, and guidance for full-year growth was increased from 4% to 5%.

Chipotle now has the opportunity to try to recreate some of Panera's success at its own locations with reduced disruption to the operation and dining experience. The development costs at Panera were estimated to be about $125,000 per location. Assuming a similar cost for Chipotle, the total investment for all locations would come out to be just over $250 million, far less than what management has poured into share buybacks in the past 12 months.

Image source: Chipotle Mexican Grill

Free catering
In early February, Chipotle kicked off an aggressive marketing campaign designed to bring customers back into its restaurants. The company offered free burritos to five million customers through mobile devices and another 21 million via direct mail. Redemption rates were 67% and 17.5%, respectively, for these offers, meaning that Chipotle has given away about seven million free burritos. At an average retail price of $7.10, that's just under $50 million in free food. However, assuming its latest food and labor costs of 66.1%, the actual direct cost to Chipotle was about $33 million -- a relatively small price to pay to regain customer loyalty considering the $255 million revenue decline during the first quarter.

This promotion has been effective. After all, it should take just a few good meals to win back customers. However, this works only with people who have not completely given up on the chain. Fortunately, that is a small number according to the company. During a presentation in March, CFO John Hartung had this to say about customer losses:

It's a small percentage. It's like 5% or 7%, I'll say that. Vast majority of people say they're going to come back. It's a matter of when. And most people say they're going to come back sooner rather than later.

So keep in mind that the bulk of Chipotle's business comes from the lunch crowd. If the company offered free or reduced price catering, it has the potential to win back multiple customers in one fell swoop. Targeting office managers and receptionists with its catering business would go a long way toward repairing Chipotle's reputation, likely at a smaller cost than sending out 21 million coupons.

Foolish final thoughts
Share buybacks and restaurant expansions send a bullish message to shareholders, and repurchasing shares when the stock is on the ropes can certainly be a smart use of capital. However, investors must keep in mind that Chipotle shares aren't depressed due to a broad market downturn, nor is the company being punished for just one bad quarter. The company is still grappling with a serious customer trust issue, so with same-store sales falling double digits, investing in initiatives that can regain their confidence should take priority over reassuring investors.

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Stocks Mentioned

Chipotle Mexican Grill, Inc. Stock Quote
Chipotle Mexican Grill, Inc.
CMG
$1,307.26 (1.48%) $19.06
Panera Bread Company Stock Quote
Panera Bread Company
PNRA

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