Company Reports

Chipotle's business strategy rests on five pillars: running successful restaurants, attracting and retaining diverse talent, making the brand visible, relevant, and loved, investing heavily in restaurant tech and innovation, and improving access and convenience for customers. In our view, the company has carved out an enduring niche in the US restaurant landscape, with competitive menu prices, extreme convenience, and "food with integrity" allowing it to lure away customers from both casual dining and traditional fast-food competitors.

We are believers in wide-moat Chipotle Mexican Grill's robust competitive position and growth prospects, but the share price leaves us with indigestion. After another quarter of outperformance, we expect to raise our $1,950 fair value estimate by a mid-single-digit percentage, but the stock would still trade at almost a 50% premium to our revised valuation, deep in 1-star territory. We suggest that investors await a more attractive entry point.

As we gear up for the release of first-quarter earnings, our top picks in the restaurant industry remain wide-moat McDonald's and wide-moat Starbucks, trading at 14% and 19% discounts to our $312 and $105 fair value estimates, respectively. While industry traffic has been depressed for two years, both brands boast strong digital platforms that allow them to defend transaction frequency without indiscriminate national discounting, and both benefit from scale-driven cost advantages that should allow them to meet the needs of the increasingly value-sensitive consumer without sacrificing financial performance. These are the two most important factors, in our view, that will distinguish the best and worst performers in our industry coverage over the coming years. The industry looks fairly priced in aggregate, trading at a 3% premium to our market-cap weighted fair value estimates. The aggregate figure masks a very bimodal return distribution: Brands like narrow-moat Wingstop (up 108% annually) and wide-moat Chipotle (74%)—which boast strong unit economics and have taken material industry transaction share—have materially outperformed brands like no-moat Wendy's (down 9%) and narrow-moat Papa John's (down 17%), which have not. Those top-performing brands are fully priced, trading at material premiums to our intrinsic valuation (163% and 52%, respectively), suggestive of meaningful execution risk.

Wide-moat Chipotle's board of directors has approved a 50-for-1 stock split, which we expect to be approved at the company's general meeting on June 6. The net effect is that each Chipotle shareholder would receive 49 extra shares for each share they hold today after the market closes on June 25, bringing the firm's total share count to roughly 1.4 billion, up from 27.4 million today. Chipotle's stock price rose nearly 7% on the news, which strikes us as myopic. To be fair, a cheaper per-share stock price could allow more retail investors to purchase the stock that might previously have been locked out of the market, but the firm's underlying cash flow prospects, competitive position, and valuation remain unchanged by the move. As a result, we expect no change to our $1,950 fair value estimate, and view shares as meaningfully overvalued.

Chipotle's business strategy rests on five pillars: running successful restaurants; attracting and retaining diverse talent; making the brand visible, relevant, and loved; investing heavily in restaurant tech and innovation; and improving access and convenience for customers. In our view, the company has carved out an enduring niche in the U.S. restaurant landscape, with competitive menu prices, extreme convenience, and "food with integrity" allowing the firm to lure away customers from both casual dining and traditional fast-food competitors.

Wide-moat Chipotle posted strong quarterly earnings, with sales growth across income cohorts and an impressive 7.4% increase in comparable transactions assuaging market concerns after a few high-profile earnings misses. While we expect to leave our 2024 targets for $11.1 billion in revenue and 8.8% unit growth largely intact, we expect to raise our $1,800 fair value estimate by a high-single-digit percentage as we now forecast a sharper increase in net unit growth and comparable store sales over the medium term. More concretely, we now expect annual comparable store sales growth of 5% and unit growth of 9.4% between 2024 and 2028, up from 4.6% and 9%, respectively, driven by normalizing construction timelines and stronger comparable store sales benefits from its throughput initiatives and loyalty program innovation than previously expected. We also plan to decrease our Morningstar Uncertainty Rating to Medium from High as we reconsider the firm's sensitivity to systematic risk factors.

As we survey the U.S. restaurant landscape looking toward 2024, the largest, chained restaurants with durable cost advantages look best positioned to outperform. We expect industry growth to remain low—just 1.3% annually in real terms through 2025, versus a long-term average of 2.5%. The sharp slowdown is predominantly attributable to slowing consumption spending, with pressured U.S. consumers already limiting restaurants’ ability to further increase prices and likely driving an uptick in industry promotional activity.

Chipotle's business strategy rests on five pillars: running successful restaurants; attracting and retaining diverse talent; making the brand visible, relevant, and loved; investing heavily in restaurant tech and innovation; and improving access and convenience for customers. In our view, the company has carved out an enduring niche in the U.S. restaurant landscape, with competitive menu prices, extreme convenience, and "food with integrity" allowing the firm to lure away customers from both casual dining and traditional fast-food competitors.

Wide-moat Chipotle posted strong third-quarter results, with $2.47 billion in sales and $11.32 in diluted EPS beating our $2.46 billion and $10.26 estimates, respectively. The earnings outperformance is reflective of both better-than-expected comparable store sales (up 5% annually, against our 3.5% estimate) and slightly lower-than-expected food cost inflation. As we balance comparable sales outperformance, strong restaurant margins, and expectations for elevated prime cost inflation in 2024, we expect to raise our $1,720 fair value estimate for the Mexican food chain by a mid-single-digit percentage, leaving shares fairly valued.

The restaurant industry looks cheap to us for the first time since fall 2022, with the recent market correction creating a buying opportunity for long-term investors. Our coverage trades at a 7% cap-weighted discount to our intrinsic valuations, with wide-moat companies like Yum Brands, Starbucks, and McDonald's looking unusually alluring, each trading at a 10%-12% discount to our respective $139, $103, and $285 fair value estimates. We recognize that slowing same-store sales pose a near-term risk, but believe that large, quick-service operators with scale-driven cost advantages and strong digital touchpoints look poised to capture market share in this dynamic environment. Restaurants are more resilient than many investors realize, with companies that outperform on the basis of "value for the money" like McDonald's and wide-moat Chipotle even posting comparable-store sales growth over the course of the 2007-09 downturn. While we expect consumer spending to slow in 2024, we continue to maintain that the U.S. will avoid an outright recession and believe that investors seeking consumer cyclical exposure would do well to consider turning toward the restaurant industry at current prices.

Chipotle's business strategy rests on five pillars: running successful restaurants; attracting and retaining diverse talent; making the brand visible, relevant, and loved; investing heavily in restaurant tech and innovation; and improving access and convenience for customers. In our view, the company has carved out an enduring niche in the U.S. restaurant landscape, with competitive menu prices, extreme convenience, and "food with integrity" allowing the firm to lure away customers from both casual dining and traditional fast-food competitors.

Chipotle's business strategy rests on five pillars: running successful restaurants; attracting and retaining diverse talent; making the brand visible, relevant, and loved; investing heavily in restaurant tech and innovation; and improving access and convenience for customers. In our view, the company has carved out an enduring niche in the U.S. restaurant landscape, with competitive menu prices, extreme convenience, and "food with integrity" allowing the firm to lure away customers from both casual dining and traditional fast-food competitors.

Wide-moat Chipotle posted second-quarter results in line with our expectations, with $2.52 billion in sales and $12.32 in diluted EPS aligning with our $2.55 billion and $11.92 expectations, respectively. With our forecasts for just north of 7% same-store sales and 8.3% unit growth falling within management's full-year guidance range, we expect to raise our $1,650 fair value estimate by a low-single-digit percentage, consistent with time value. The market's reaction was harsh, seeing shares fall 9% in aftermarket trading, but we view the drop as more reflective of unrealistic expectations than of any glaring shortcoming during the quarter. Shares trade at about an 11% premium to our revised intrinsic valuation.

We don't expect wide-moat Chipotle Mexican Grill's first international development agreement to prove financially material, and we continue to view the shares as pricey. Nevertheless, we appreciate the strategic rationale behind the deal with Alshaya Group and will keep a close eye on its success; reasonable uptake in the Middle East and Africa could augur well for a deeper foray into larger and more strategically important markets in Western Europe while increasing the chances of entry into markets like China that global restaurant peers have traditionally approached through franchise agreements.

Restaurant stocks look expensive as we take the industry's pulse, with names in our coverage trading at a market-cap-weighted 10% premium to our intrinsic valuations. While demand has held up nicely to date, we're seeing weak spots, with persistent declines in traffic and items per check suggesting price-conscious consumers and a more challenging pricing environment to come. Nominal same-store sales growth remains healthy, up around 5.7% industrywide over the past three months (RMS data), but traffic (down 1.4%) and items per check (down 3.7%) remain points of concern. We expect slowing sales momentum into the first half of 2024, resulting in a more promotional environment for the industry and a three- to four-year route to normalized restaurant-level profitability. The industry's bargain bin looks sparse, but we see modest upside in Wendy's and Starbucks shares, which trade at 6% and 2% discounts to our $23 and $104 fair value estimates, respectively.

Chipotle's business strategy rests on five pillars: running successful restaurants, attracting and retaining diverse talent, making the brand visible, relevant, and loved, investing heavily in restaurant tech and innovation, and improving access and convenience for customers. In our view, the company has carved out an enduring niche in the U.S. restaurant landscape, with competitive menu prices, extreme convenience, and "food with integrity" allowing the firm to lure away customers from both casual dining and traditional fast-food competitors.

We plan to raise our $1,550 fair value estimate for wide-moat Chipotle by a mid-single-digit percentage after the firm reported surprisingly strong traffic and margin figures in its first-quarter earnings report, consistent with the market's reaction in afterhours trading. By any reasonable measure, the firm posted a blowout quarter, with $2.4 billion in sales and $10.50 in diluted EPS comfortably edging our $2.3 billion and $8.35 forecasts, respectively. Importantly, the firm's nearly 11% comparable store sales growth was balanced between check (7%) and traffic (4%), suggesting that despite double-digit price increases, the firm's value proposition hasn't yet outrun its core customer. Bolstered by moderating food costs and sales leverage, the Mexican fast casual chain also posted a restaurant-level margin beat, with a 25.6% figure healthily edging guidance of roughly 24% for the quarter.

The restaurant industry has proven surprisingly resilient despite stout macroeconomic headwinds, but between normalizing consumer spending patterns, a widening value gap with the grocery channel, and early signs of price sensitivity, we believe that 2023 is shaping up to be challenging. Despite early indications of a strong first quarter, we continue to expect a softer second half of the year, limiting near-term margin recovery as restaurants are reluctant to outprice their core customer. To this effect, traffic and items per check have declined in each of the past 10 months industrywide—through February 2023—and we continue to view exclusively price-driven comparable store sales growth as a tenuous long-term strategy. We sport a carb-heavy value menu in the industry, with wide-moat Domino's and narrow-moat Toast representing our top picks, trading at 16% and 18% discounts to our $397 and $21.50 fair value estimates, respectively.

Chipotle's business strategy rests on five pillars: running successful restaurants, attracting and retaining diverse talent, making the brand visible, relevant, and loved, investing heavily in restaurant tech and innovation, and improving access and convenience for customers. In our view, the company has carved out an enduring niche in the U.S. restaurant landscape, with competitive menu prices, extreme convenience, and "food with integrity" allowing the firm to lure away customers from both casual dining and traditional fast-food competitors.

Wide-moat Chipotle's fourth-quarter earnings certainly weren't brilliant. The firm's $2.181 billion in sales, 5.6% same-store sales growth, and $8.29 in adjusted EPS missed our estimates of $2.24 billion, 6%, and $8.75, respectively, with FactSet consensus estimates falling within a stone's throw of our own. The firm saw meaningful declines in traffic and mix, fully offset by 13.5% average price increases—which would be sufficient to upset investors' appetites if it weren't for a strong recovery so far in 2023. More concretely, the fourth quarter saw transactions fall 4% from a year ago, driven partially by uninspiring uptake of the firm's limited-time guajillo steak offering, which lapped a tremendously successful beef brisket launch a year ago. Taken in tandem with a margin drag from elevated sick leave (60 basis points) and lower loyalty program breakage estimates (80 basis points), restaurant margins of 24% fell quite a bit behind our 25.4% forecast. On a net basis, the earnings miss leads us to trim our $1,560 fair value estimate by a low-single-digit percentage (2%-3%), with the market's 4%-5% drop after the release striking us as harsh.