By Barbara Gray, CFA – April 20, 2012 – I was a bit nervous yesterday after market close as I waited for Chipotle Mexican Grill (CMG-NYSE) to report its 1Q12 results. Although I strongly believe in the company’s long-term value creation potential, the stock had risen 16% (versus only a 3% gain in the DJIA) in the past quarter and was trading at a premium valuation of nearly 40 times next year’s earnings. I breathed a sigh of relief as the headline numbers scrolled across my screen…
Revenue was up 26% with comparable store sales growth of 13% – the 7th consecutive quarter of double-digit comparable sales growth. The restaurant operating margin was up 220bp to 27.4% (lower labor, occupancy, and promotional costs were slightly offset slightly by higher food costs). EPS came in at $1.97 up from $1.46 last year – a 35% gain. The company opened 32 new restaurants in the quarter, bringing the total up to 1,262 – with average sales volumes reaching a record high of $2.072 million. And the company ended the quarter with $370 million in cash and equivalents (and no debt!).
I have to admit I am a latecomer to the Chipotle story. If you recall, back in January 2011 I published my paper titled “Social Media: An Exposing Disruptive Force” and identified lululemon (LULU-NASDAQ) and Starbucks (SBUX-NASDAQ) as companies having heart and soul and Yellow Media Inc. (YLO-TSX) as being a “shell”. As I watched the stock prices of LULU and SBUX rise and YLO fall, I gained more confidence in my thesis and started to search for other companies with heart and soul. After reading John Mackey’s thought-provoking “Conscious Capitalism” essay, I decided to take a look at Whole Foods Market (WFM-NASDAQ) as a potential company with heart and soul. Soon after, one afternoon I was watching Mad Money (I think poor Brady watches more hours of CNBC than cartoons!) and Cramer started singing the praises of Whole Foods Market – and then Chipotle Mexican Grill. I have to admit I was skeptical as I have a personal dislike for fast-food and I had never visited a Chipotle as they only had two restaurants in Canada (but in Toronto, not Vancouver). But I decided to put my analyst hat on and take a closer look…
I really liked the playful and creative tone of the company’s website – it felt very authentic and human. And as I started to dig into the story behind Chipotle I discovered the company is about much more than selling burritos. Its founder, Steve Ells, is actually a graduate of the esteemed CIA (Culinary Institute of America) and began Chipotle Mexican Grill inspired by the simple philosophy to demonstrate that food served fast doesn’t have to be a traditional “fast-food experience”. And his vision has evolved to now change the way people think about and eat fast food guided by his mission of “Food With Integrity”. The company advocates this mission by addressing the topics of animals, people, and the environment and talks about “we work hard to find farmers and ranchers who are doing things the right way”, “we can talk about all of the procedures and protocols we follow and how important they are – but it really comes back to the people”, and “we work hard to source ingredients in ways that protect this little planet of ours.” I also respected that the company had built its entire restaurant base from scratch, resisting the temptation to accelerate its growth through taking acquisition or franchising short-cuts. And as I read through the past few year’s of quarterly conference call transcripts, I was struck with how genuinely passionate management was about its “Food with Integrity” mission.
Excited that I might have found a company with heart and soul, I decided to crunch the numbers and figure out its business model so I pulled up its annual/quarterly reports and its conference call transcripts for the past few years. The numbers looked impressive – in 2010, Chipotle earned $1.8 billion in sales from its 1,020 restaurants, equating to average sales per restaurant of $1.8 million. And through the dark years of 2008 and 2009, the company managed to achieve both positive same-store sales growth and double-digit unit growth – likely a testament to its strong stakeholder equity foundation. But it wasn’t until last spring when I drove down across the border to Bellevue, Washington (the closest Chipotle from Vancouver) and walked into a Chipotle restaurant that I understood why people fall in love with Chipotle and become loyal and frequent guests. Even though it was 2pm on a rainy Sunday, there was a long line-up. I was really impressed with how friendly, professional, and efficient their front-line crew was. But what blew me away was the food itself – so fresh and flavorful – I swear their guacamole is the best I have ever tasted. I was sold!
Back to the conference call… Steve Ells started talking about how the major drivers of the company’s business are its unique food and people culture – and this theme continued throughout the call. I have to point out this is not the norm as most conference calls are focused on just the numbers and how the company is achieving operational and cost efficiencies. I encourage you to take a look at the conference call on Seeking Alpha (SeekingAlpha). One of the highlights of the quarter was the increased awareness and public dialogue Chipotle generated for its “Food with Integrity” greater purpose when it aired its 2-minute animated “Back to the Start” film during The Grammys. If you haven’t yet seen this multi award-winning soul-stirring film that is set to Cold Play’s haunting song “The Scientist” sung by Willie Nelson, I highly recommend you watch it (below). The airing of the film generated 22,000 tweets, over 33 million Twitter impressions, and 150 million media impressions. I believe this really highlights how authentic companies with a greater purpose will be able to leverage social media to build emotional connections with customers and psychological attachments to what the company stands for.
The bottom line is that I believe companies with heart and soul, like Chipotle, are best positioned to outperform in this decade of the Social Revolution. I am convinced that companies that derive their competitive advantage by exploiting their stakeholders will start to see their economic moats erode. Meanwhile, heart and soul companies, like Chipotle, that are working to build higher levels of social capital will be able to create new generative moats and achieve higher than expected growth. And that is why I believe Chipotle is a story worth sharing.
Disclosure: I have a LONG position in: Chipotle Mexican Grill (CMG-NYSE), lululemon athletica, inc. (LULU-NASDAQ; LLL-TSX), Starbucks (SBUX-NASDAQ), and Whole Foods Market (WFM-NASDAQ).