EUR 850.00 For Business Accounts Only

Morningstar | Chipotle Seeing Early Returns From CEO Niccol's Appointment With Several Initiatives in the Pipeline

We believe investors should walk away from Chipotle's third-quarter update with optimism, as it's clear that new CEO Brian Niccol is delivering early returns with several intriguing initiatives left in the pipeline. While there's no denying the potential appeal of new menu items, restaurant formats (including drive-up windows), and a new loyalty program, it's the ability to execute basic functions like advertising and throughput that was the most impressive takeaway and helps to reinforce the brand behind our narrow moat rating.

While comps of 4.4% were slightly behind Wall Street expectations of 4.9%, it tells us two things. One, the new "For Real" advertising campaign is connecting with consumers while helping to nullify the well-publicized food-safety incident in Ohio. Comparable transactions were flat, but barring a more pronounced economic downturn, we believe transaction growth should turn positive in the fourth quarter with comps remaining in the mid- to high single digits over the near future. Two, digital orders (up 48% to 11.2% of total sales) and delivery are benefiting store-level utilization and should eventually drive greater operating leverage. As it optimizes mobile order and delivery, we believe Chipotle will be positioned to introduce new products like quesadillas, nachos, avocado tostadas, and chocolate milkshakes that should stimulate consumer curiosity without adding undue operational complexity.

While management did not provide full 2019 guidance, we were encouraged that it is planning for a modest increase in store openings (140-155 versus 130-150 in 2018, less the previously announced 55-65 closures). We would not be surprised to see market optimism prop up Chipotle's stock as comps accelerate, though we're only planning a modest increase to our $400 fair value estimate, which already assumes restaurant margins and operating margins will recover to the low to mid-20s and the low to midteens, respectively, over the next five years.

Digging deeper into the quarter, we believe the areas of emphasis that Niccol highlighted from last month's All Managers conference square with the takeaways from our Oct. 2 piece, "The Restaurant Industry Is Evolving—Your Key Performance Benchmarks Need to, Too," including (1) throughout excellence; (2) restaurant team stability and development; (3) great-tasting food; and (4) customer hospitality. In our view, Niccol and the rest of Chipotle's management team recognize that convenience is the key priority for its customers, and are in the early stages of developing an operational and technology blueprint to best address these needs.

Looking beyond 2018, our model is already aligned with management's restaurant guidance --around 140-155 units per year, versus an average of 230 openings during 2015-16, though the possibility of drive-thru locations or formats using pickup cubbies could offer upside to our current assumptions. We expect average annual comps of 5% from 2019-21 due to new menu innovations, guest experience improvements, and second assembly line delivery/catering orders. Altogether, we expect high-single-digit revenue growth over the next five years. Coupled with wage rate inflation across much of the U.S. over the next few years, food-safety initiatives, and additional labor and restaurant investments to augment the consumer experience, we expect restaurant margins and operating margins will recover to the low to mid-20s and the low to midteens, respectively, over the next five years, but still below the mid- to high 20s and high teens posted just a few years ago.