Chipotle: More Than a Comeback Story, but Shares Rich

After posting industry-leading comps of 11% (highlighted by 7.5% transaction growth) and restaurant margins expanding 210 basis points to 20.8% during the third quarter, it's clear that Chipotle's CMG progress under CEO Brian Niccol is more than your average comeback story. We share Niccol's view that Chipotle can "deliver above industry growth for many years to come," especially with its digital, restaurant format, and menu innovation initiatives starting to scale (while also supporting our narrow-moat rating). That said, our optimism is tempered by a market valuation that assumes unrealistic long-term expectations.

Comps are dominating the headlines following Chipotle's update--coming in ahead of market expectations of 9%--but we believe there are three takeaways that longer-term investors should focus on. Chipotle's digital efforts (mobile ordering and delivery, which increased 88% to 18.3% of sales and should finish 2019 at about 20%) continue to outpace most industry peers while unlocking margin expansion potential. This includes the "Chipotlane" mobile order/pickup lane, which has been successful in early tests and will likely be a feature in the majority of new openings (including the 150-165 expected in 2020) We're also intrigued by Chipotle's "stage-gate" process, which measures a new product from a customer, financial, and operations standpoint in a few test markets before a nationwide rollout. Chipotle's carne asada promotion--which will end in November--is validation of this process and will be a blueprint for new product launches in future.

Based on the comp benefit from new product launches and the cash-on-cash return benefits of the Chiptolane format, we're planning to raise our $600 fair value estimate by almost 10%. While we believe the market will continue to reward this name with a premium valuation in the near term, the natural moderation in top-line trends could bring Chipotle's current trading multiple (45 times earnings) closer to its peers.

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