Chipotle Succeeds By Flouting Conventional Wisdom

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If there's one thing officials at Chipotle Mexican Grill want you to know, it's that it is not like other restaurant companies.

Sure,Chipotle 's ( CMG ) fast-casual Mexican eateries prepare food in kitchens and serve it to guests who pay money for the privilege, just like at other restaurants.

And yes, business tends to pick up around lunch and dinner, when folks queue up to order the company's freshly prepared burritos, tacos and salads.


And yes, Chipotle needs to keep food, labor and other costs in line if it wants to hit its margins and deliver the kind of profits that make investors tingle with joy.

But that's where the similarities end -- at least from Chipotle's point of view.

"Our business is pretty different than others in the category in that we don't rely on some of the things others depend on, such as limited-time offers, merchandise ties and new menu items," said Chris Arnold, the company's communications director.

No Smoke And Mirrors

Chipotle doesn't depend on "gimmicks" to drive customers through its doors, Arnold says. Instead, it relies on the company's "food culture and people culture."

On the food side, Chipotle focuses on "finding the best ingredients we can and preparing them using classic cooking techniques," Arnold told IBD.

On the people side, the company looks to hire the right workers and develop them into managers.

Ninety-eight percent of Chipotle's managers are hired internally from the company's rank-and-file crew, Arnold says. Last year it promoted more than 9,000 people into management positions.

"This leads to a better customer-service experience and more operational efficiency," Arnold said.

It's hard to argue with the results. Chipotle almost always churns out double-digit sales and profit growth and consistently ranks among the top stocks in the restaurant sector.

Its financial might was on display during the second quarter, which Chipotle reported after the close on July 21.

The company stomped all over earnings and sales estimates despite implementing its first price increase in three years to help cover higher food costs.

The next day, Chipotle's stock price soared nearly 12% to 659.77 for the biggest single-day gain since last fall. Shares currently trade near 678.

Chipotle logged earnings of $3.50 a share for the quarter, up 24% from the prior year and well ahead of estimates for $3.08 a share.

Overall sales gained 29% to $1.05 billion, beating views for $989.55 million. It was the third straight quarter of accelerated top-line growth.

Same-store sales climbed 17.3% vs. expectations for a 10.5% gain. Chipotle also raised its full-year same-store sales guidance to the midteens from its prior guidance of growth in the high single digits.

"It's the best traffic number in the industry," Sterne Agee analyst Lynne Collier said after the earnings report. "Rarely do you see numbers this high. Most of the companies we follow have recently put up flattish to slightly negative traffic numbers."

In a report, Citigroup analyst Gregory Badishkanian said there was "no single driver" of Chipotle's strong same-store sales performance, though he did point to a few key drivers.

One was a bigger (though still small) contribution from Chipotle's catering business. It represented 1.6% of sales during the second quarter, up from 0.3% the prior year.

Badishkanian also says Chipotle benefited from improved marketing during the quarter.

Compared with other restaurant operators in the fast-casual and fast-food sectors, Chipotle doesn't spend a whole lot of money on marketing. While most companies spend 3% to 5% of their revenue on advertising, Chipotle spends 1.75%, Arnold says.

"We are not pursuing the kinds of gimmicks that fast-food companies pursue, such as new products," he said. "Those are very expensive; a lot of R&D goes into developing new menu items, then you have to spend a lot of money on marketing."

Instead, Chipotle focuses on non-traditional marketing efforts that range from producing Web videos and sponsoring food and music festivals to partnering with local farmer's markets.

While marketing helps drive top-line growth, Chipotle looked to bolster its bottom line with a rare price increase during the second quarter to help offset rising costs of beef, avocados and cheese.

"We generally try to hold the line on pricing and raise prices as a last resort," Arnold said. "We just felt like we had to do it."

Badishkanian, who recently met with Chipotle management, noted after the meeting that the company is not seeing "any impact" from raising prices, and added that Chipotle still feels that its prices are too low in the Northeast.

One reason customers aren't terribly concerned about the higher prices is they are confident in the quality and freshness of Chipotle's food, analysts say. That holds true not just for Chipotle, but also for other fast-casual chains such asPanera Bread ( PNRA ), Qdoba Mexican Grill -- a division ofJack in the Box ( JACK ) -- and Baja Fresh, according to a recent report from analysts at research firm Trefis.

Top Of The Line

Fast-casual restaurants provide more "freshly prepared and high-quality food than traditional quick-service restaurants (QSR), all in an upscale and inviting ambiance with meals ranging from $8 to $15," Trefis said, adding, "Big QSR brands such asMcDonald's ( MCD ), Subway andStarbucks ( SBUX ) have been facing a huge threat by the leading fast-casual restaurants, as the traffic growth in the latter segment surpassed that of every other segment for the fifth consecutive year (in 2013)."

To help meet rising customer demand, Chipotle opened 45 new restaurants during the second quarter to bring the total to more than 1,600. That total includes 17 Chipotle restaurants outside the U.S. and seven ShopHouse Southeast Asian Kitchen restaurants.

The company also has a stake in one Pizzeria Locale in Denver.

In any given year, about 80% of its expansion is in existing markets, Arnold says.

"We have a pretty good idea of what the returns will be in those markets," he 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 , PNRA , JACK , MCD , SBUX

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