Chipotle Mexican Grill (CMG) operates Mexican food restaurants. It offers a focused menu of burritos, burrito bowls, tacos, and more.
Chipotle Mexican Grill is a company with a measurable competitive advantage and a successful online strategy that is well run by a competent management team. As a result, we are bullish on the stock.
CMG has a measurable competitive advantage, which we will highlight in this article. There are a couple of ways to quantify a company’s competitive advantage using only its income statement. The first method involves calculating the company’s earnings power value (EPV).
Earnings power value is measured as adjusted EBIT after tax divided by the weighted average cost of capital, and reproduction value (the cost to recreate the business) can be measured using a company’s total asset value. If the earnings power value is higher than the reproduction value, then a company is considered to have a competitive advantage.
For CMG, the calculation is as follows:
EPV = EPV adjusted earnings / WACC
$8.027 billion = $578 million / 0.072
Since Chipotle has a total asset value of $6.65 billion, we can say that it has a competitive advantage. In other words, assuming no growth for Chipotle, it would require $6.65 billion of assets to generate ~$8.03 billion in value over time.
Another way to quantify a competitive advantage is by looking at a company’s gross margin because it represents the premium that consumers are willing to pay over the cost of a product or service. An expanding gross margin indicates that a sustainable competitive advantage is present.
If an existing company has no edge, then new entrants would gradually take away market share, leading to a decreasing gross margin as pricing wars ensue to remain competitive.
In Chipotle’s case, gross margins have expanded in the past several years, growing from 29.2% in 2016 to 38% in the last 12 months. As a result, its gross margins indicate that a competitive advantage is present in this regard as well.
Chipotle has a strong online presence, which is one of the reasons why it was so successful during the pandemic. As a result, measuring Chipotle’s website traffic might be able to provide investors with important clues.
Taking a look at the website traffic, we can see that total global visits have been trending up. Therefore, this is consistent with CMG’s revenue and earnings growth in the most recent quarter, which beat analysts’ expectations.
Going forward, investors may want to keep an eye on its website traffic in order to gauge the effectiveness of its online strategy.
CMG is an Efficient Company
Chipotle needs to hold onto a lot of inventory to keep its business running. Therefore, the speed at which it can move inventory and convert it into cash is very important in predicting its success. To measure its efficiency, we will use the cash conversion cycle, which shows how many days it takes to convert inventory into cash. It is calculated as follows:
CCC = Days Inventory Outstanding + Days Sales Outstanding – Days Payables Outstanding
Chipotle’s cash conversion cycle is -6, meaning the company converts inventory into cash before having to pay suppliers. Basically, Chipotle doesn’t have to put up any money to finance inventory purchases because it can move its inventory and collect the payments while still on credit. Thus, Chipotle’s suppliers are essentially financing its operations.
Another way to measure the company’s efficiency is by using a metric called the economic spread, which is calculated as follows:
Economic Spread = Return on Invested Capital – Weighted Average Cost of Capital
The idea is very simple; if the return on invested capital is greater than the cost of that same capital, then the company is creating value for its shareholders through well-thought-out projects. Otherwise, the company is considered a value destroyer.
For Chipotle, the economic spread is a follows:
Economic Spread = 11.2% – 7.2%
Economic Spread = 4.0%
As a result, we can say that CMG is creating value for shareholders. In addition, both metrics indicate that the management team is very competent at operating the company, which should equate to solid long-term returns for investors.
To measure Chipotle’s risk, we checked financial leverage is an issue. The first thing we did was look at its debt-to-free-cash-flow ratio. Currently, this number stands at 4.4 (if including lease obligations as debt).
Overall, we don’t believe that debt is currently a material risk for the company because its interest coverage ratio is 225 (calculated as EBIT divided by interest expense).
However, there are other risks associated with Chipotle. According to Tipranks’ Risk Analysis, the company has disclosed 26 risks in its most recent earnings report. The highest amount of risk came from the Production category.
The total number of risks has decreased over time, as shown in the picture below.
Wall Street’s Take
Turning to Wall Street, Chipotle has a Moderate Buy consensus rating based on 14 Buys, six Holds, and zero Sells assigned in the past three months. The average Chipotle price target of $1,893.70 implies 31.5% upside potential.
CMG stock has seen great returns over the past several years, which is no surprise after going over some of its numbers. In addition, the company has the backing of analysts, who believe that there is more upside, going forward. As a result, we are bullish on the stock.
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