Chipotle Cooks Up Healthy Growth With Better Burritos


The menu board hasn't changed much in two decades.Chipotle Mexican Grill ( CMG ) continues to offer a simple array of tacos, burritos and basic sides like chips and salsa.

But the Mexican-themed fast-food chain has grown rapidly over two decades thanks to the innovation it brings to what it puts inside those flour and corn tortillas.

A decade ago Chipotle started using meat from cattle, pigs and chickens raised in humane fashion, and those not given hormones or antibiotics. It now serves 120 million pounds a year of responsibly raised meats, as it calls them. In 2008, the burrito joint started looking to farmers near its restaurants for as much of its produce as possible -- jumping on the "locavore" trend. Chipotle says it's now on pace to serve 15 million pounds of local produce this year, up from 10 million in 2012.

'Food Culture' Consciousness

Chipotle's latest push is to label any menu items containing genetically modified organisms, or GMOs, and eventually to phase them out completely at all its restaurants. The company is the first national chain to voluntarily label such foods and says most of its menu is already GMO-free.

"Our marketing continues to highlight our food culture and how it differentiates us from other restaurants, as we believe customers are increasingly receptive to messages about where their food comes from and why that's important," Steve Ells, co-CEO, told analysts after reporting Chipotle's better-than-expected second quarter sales and earnings.

The burrito joint is a leader in the rapidly growing fast-casual niche, sandwiched between fast food restaurants and the slightly pricier casual dining chains. It delivers what it calls "Food With Integrity" in sleek, modern restaurants. It serves items up quickly, to order, and relatively cheaply.

Analysts say that not-so-secret sauce is deceptively difficult for competitors to match.

"They make it look simple. They just put those things together, but no one seems to be able to duplicate it," said Mitchell J. Speiser, an analyst at Buckingham Research.

Ells opened his first Chipotle in Denver, Colo., in 1993. The chain, which has since grown to about 1,500 restaurants, celebrated its 20th anniversary in July.

It's the second-largest Mexican-themed chain in the U.S., after global giant Taco Bell, owned byYum Brands ( YUM ), which has about 5,700 U.S. locations. Chipotle is the fourth largest firm by market cap in IBD's Retail-Restaurants industry group, which is now ranked No. 34 of 197 groups. Chipotle is outsized byMcDonald's ( MCD ),Starbucks ( SBUX ) and Yum Brands.

An early investor in Chipotle, McDonald's became majority owner in 2000. It sold some shares at the January 2006 IPO and divested completely by that year's end.

McDonald's last month posted disappointing Q2 results, mostly on European and Asian weakness, and modest U.S. growth.

Chipotle operates almost exclusively in the U.S. It has just five restaurants in Canada, five in London, and one in Paris.

In 2011, Chipotle tested its business model using an Asian theme, with ShopHouse Southeast Asian Kitchen in Washington, D.C. Chipotle opened a second ShopHouse earlier this year in Los Angeles. The company plans to open six more locations in those two cities by the middle of 2014.

America's The Frontier

While Chipotle says it's happy with its overseas performance and the new ShopHouse concept, the company says the bulk of its growth will come from its core taco and burrito chain in the U.S.

Most analysts say Chipotle could grow to 3,000 restaurants in the U.S. alone, without cannibalizing sales at existing locations.

New restaurants are key as sales growth slows at existing locations. Chipotle opened 92 new restaurants in the first six months this year, part of plans for 165 to 180 in 2013. But sales at restaurants open at least a year climbed just 5.5% in the second quarter and 3.4% for the first six months of 2013. That's well shy of the double-digit growth rates Chipotle posted in parts of 2010, 2011 and the start of 2012.

The company is guiding toward low- to mid-single digit same-store growth for 2013.

Chipotle hasn't raised menu prices in most of its markets in two years, notes David Tarantino, analyst at Robert W. Baird & Co. In past years when the company's food choices pushed up costs, they've passed that on to consumers. The restaurant chain could raise prices again as it continues the GMO-free rollout.

"I think they have some pent-up ability to take pricing (up) when they decide to do it," Tarantino said.

Chipotle has hit speed bumps in past efforts to boost the quality of its food. Suppliers can't always keep up with demand for free-range, grass-fed and antibiotics-free meat. In 2010, it briefly dropped back to traditionally raised chicken in some markets. And early this year, it went back to conventionally raised beef in some restaurants. Chipotle says it labels the food accordingly.

Those supply woes underscore a major challenge for any competitor that would try to match Chipotle on food quality. The supply network for such meat and produce is much more fragmented. And Chipotle has already built a relationship to buy much of what's available.

"McDonald's couldn't go naturally raised overnight. There's not enough supply," Speiser said.

Competition remains fierce in the fast-casual space, though. Darren Tristano, executive vice president of restaurant consulting firm Technomic, says U.S. sales in that sector could rise 10% a year for at least the next three years, driven by new restaurant growth and diners trading down from more expensive full-service sit-down meals.

In one competitive move, Yum's Taco Bell is rolling out a more upscale Cantina Bell menu with heavy television promotions featuring its celebrity chef Lorena Garcia.

Slicing The Sales Tortilla

Taco Bell had 44.7% of the Mexican-themed restaurant market by sales in 2012, Technomic estimates, down slightly from the year before. No. 2 Chipotle had 16%, up slightly. No. 3, privately held Del Taco, had just a 3.8% share with its 551 restaurants, mostly in Western states.

Some small regional chains are growing fast, nibbling at Chipotle's customer base in certain markets.

Privately held Freebirds World Burrito ended 2012 with just 92 restaurants, mostly in California. But it grew sales by 53.8%, according to Technomic estimates. And Ohio-based Hot Head Burritos doubled its sales in 2012 as it almost doubled its restaurant count.

"You're going to see a lot of these brands evolve and grow and become national players, and we're going to see a saturation point, probably very quickly," Tristano said.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , Investing Ideas

Referenced Stocks: CMG , MCD , SBUX , YUM

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