Lofty Expectations for Chipotle Leave Little Room for Error

By almost any metric,

Looking ahead, 2015 is a pivotal year as Chipotle laps last year's comps and margin gains. In our opinion, recent comp trends validate the brand's tremendous pricing power, as transaction growth contributed 7.8% to comps despite the 6.3% menu increase taken last summer. We view management's outlook calling for low- to mid-single-digit comps in 2015 as extremely conservative and believe the market will be disappointed by anything less than low-double-digit growth in 2015. From a cost standpoint, beef prices are likely to remain elevated--keeping food costs around 35% of sales in the early part of the year--which will make restaurant margin gains more difficult to come by than the back half of 2014. We expect 70-80 basis points of restaurant margin improvement to 28% in 2015, though there could be upside if management carries out targeted price increases.

We're not planning material changes to our $615 fair value estimate beyond time value of money adjustments. Our model still pegs Chipotle as one of the more significant long-term consumer growth stories--we anticipate midteen average annual top-line growth and restaurant margins expanding to the low 30s over the next decade--though we believe investors must also factor a more crowded fast-casual landscape into forward estimates. Our narrow moat rating suggests the company can withstand increased competition and drive strong returns on invested capital, but does not imply that 2014 trends will last into perpetuity.

Management left its 2015 outlook largely intact, with guidance for 190-205 restaurant openings striking us as realistic (particularly when factoring in the company's underappreciated restaurateur pipeline), but its comp target in the low- to mid-single-digit range appears conservative when factoring in price increases that will provide a tailwind through much of the early part of the year, ongoing contribution from peak hour throughput improvements and catering orders, and January transaction trends continuing at a pace similar to the fourth quarter (putting the company on pace for low to mid-teen comps in the first quarter, according to our estimates). Although management said it was presently seeing limited top-line impact from new fast-casual players entering the market, we still believe the combination of commercial real estate availability (partly a byproduct of the dearth of retail growth concepts in the market today) and favorable lending economics for nascent fast-casual concepts will eventually put downward pressure on Chipotle's same-store sales trends. However, we still believe normalized comps in the mid- to high-single-digit range, an ultimate store base of 5,000-6,000 units across all announced concepts, and restaurant margins north of 30% are achievable over a longer horizon, despite the presence of increased competition.

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