A Closer Look At Chipotle Mexican Grill’s Key Valuation Drivers

Chipotle Mexican Grill’s (NYSE: CMG) stock price has declined by nearly 22% in the last three months. The company has lost nearly 50% of its valuation (high of nearly $725 in October 2015 to a low of around $320 in September of this year) ever since news of the E. coli virus impacting its food broke out two years back. With its “Food With Integrity” tag line and focus on high quality natural ingredients, Chipotle was a high growth company before it was hit by the virus impacting its customers, and consequently revenues, negatively. While it appeared that the company is slowly regaining its reputation another isolated virus incident shook its fragile reputation. The company is trying various initiatives such as a focused advertising campaign, new menu items, enhanced food safety measures, to bring back customers to its stores; however it has not met with much success. Slower revenue growth and mounting expenses due to promotions are impacting the company’s profitability negatively.

Our price estimate for Chipotle is $328 which is based on three key drivers:

Number of restaurants : Chipotle’s expansion is on track despite lower customer traffic at its existing stores. The company is adding around 195-200 restaurants every year and we expect this trend to continue over our forecast period. We expect a linear growth in Chipotle’s total restaurants and the company to have around 3,800 units by 2024. A slower growth in the number of restaurants can impact the company’s valuation significantly. For instance, there can be a more than 20% downside to our price estimate if the company is able to grow its restaurants to only 3,000 by the end of our forecast period. While its growth plans are currently on track if the company is unable to regain its lost reputation, it might decide to curtail long term expansion.  Click here to modify this driver and identify its impact on the company’s valuation.

Average Number Of Customer Visits Per Restaurant Per Year: As the popularity of Chipotle’s food grows and it wins customers back with its marketing efforts and menu innovations, we expect a steady albeit slow growth in the average number of visits per restaurant per year. We also assume that new restaurants will be able to attract a modest traffic in the first year of operation. However, if the company is unable to win customer trust and visits grow at a much slower rate compared to our expectations, there can be a significant downside to our price estimate. Click here to modify this driver and identify its impact on the company’s valuation.

Average Spend Per Customer Visit: Restaurants are increasingly focusing on menu items which coax customers to spend more – either by way of choosing a high quality and hence pricey product or adding more sides to their order to try out the new innovative products. Starbucks is focusing on gourmet coffee and food and McDonald’s is introducing fresh patties for its burgers to increase customer spend per visit. Chipotle Mexican Grill is also looking at various ways to make customers spend more at its stores such as introduction of desserts, the new queso dip, and other new menu items. The company also increased its prices at certain locations to meet the rising costs of raw materials. However, given its fragile reputation, we do not expect a significant increase in this driver over our forecast period and any decline can impact the valuation of the company negatively. Click here to modify this driver and identify its impact on the company’s valuation.

Apart from the above three key drivers, keeping costs under control is also crucial for Chipotle. Rising prices of avocado, increased spend on marketing, and food safety is adding to its expenses. We expect a gradual decline in costs as a percentage of revenue as the company generates higher revenues in the future.

Our price estimate for Chipotle (slightly higher than its current market price) is based on the key assumption that the company will be able to win customers back and expand its restaurants steadily over the next few years. However, lower customer traffic without a corresponding increase in customer spend can lead to a significant downside in our price estimate. On the other hand if the company’s new menu items attract more customers and it is able to regain its lost glory, there can be a significant upside to our price estimate.

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