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Morningstar | Digital and Delivery Position Chipotle for Near-Term Growth, but Reflected in Current Price

With a continuation of strong comps (up 10%, including almost 7% transaction growth, 2% pricing, and 1.5% mix benefit from delivery orders) and solid restaurant margin gains (up 120 basis points to 20.9%) in narrow-moat Chipotle Mexican Grill's second quarter, the natural questions facing investors are (1) what comp trends will look like as the firm laps consumer adoption of its digital and delivery initiatives in the back half of the year and (2) whether the market is pricing in overly aggressive long-term assumptions.

It's reasonable to assume some near-term comp moderation, but with consensus calling for just over 6% in the back half of the year, the market may be underestimating Chipotle's digital efforts (both mobile ordering and delivery, which increased 99% to 18.2% of revenue and should finish the year in the low 20s), customer incentives tied to its loyalty program, expansion of its "Chipotlane" mobile order/pickup lane, and new products (including quesadillas, which may offer a blueprint for nachos and dessert products). We're comfortable calling for 8% average comps in the back half of 2019, which should be enough to drive restaurant margins to 20% and adjusted EPS of around $13.50.

Despite our near-term optimism, we still struggle with Chipotle's valuation. We plan to raise our $550 fair value estimate by 5%-10% due to increased near-term top-line and margin expansion visibility. However, with a current price north of $750 per share, we believe the market is pricing in almost 5,000 units over the next 10 years, with average annual comps in the mid- to high single digits, restaurant margins exceeding 27%, and operating margins pushing 19% over that period. While we give CEO Brian Niccol credit for Chipotle's comeback and believe the market will continue to reward the stock with a premium valuation near term, the natural moderation in top-line trends in 2020 could bring Chipotle's current trading multiple (45 times earnings) closer to peers.

After adjusting for Chipotle's second-quarter update, our model assumes 9% comps in 2019--consistent with management's updated guidance of high-single-digit growth for the year--helped by the aforementioned second-half drivers as well as continued contribution from digital order pickup shelves, in-app delivery, and new marketing efforts. Even with increased investments in strategic initiatives, we continue to believe Chipotle is positioned to drive restaurant margins modestly higher, with our model calling for almost 20% in 2019 versus 18.7% in 2018. Implied guidance for food costs around 33% of revenue (which could experience upside if avocado pricing normalizes), labor costs in the mid-26% range, marketing costs of 3%, and an effective tax rate range of 26%-29% strikes us as realistic and will probably put full-year adjusted EPS around $13.50 (excluding restructuring and other one-time costs). Over the next five years, we now anticipate low-double-digit revenue growth (5% unit growth and 6% average annual comps) with restaurant margins and operating margins recovering to the low to mid-20s and the midteens, respectively.