AVI - Chipotle Mexican Grill (CMG)

Shreyas Lakshminarayan, Gursimar Somal

1. Explain (simply and in your own words) what the company does

Chipotle Mexican Grill, Inc., together with its subsidiaries, develops and operates Chipotle Mexican
Grill restaurants. As of December 31, 2016, the company operated 2,198 Chipotle restaurants
throughout the United States, as well as 29 international Chipotle restaurants; and 23 restaurants
with non-Chipotle concepts. The company was founded in 1993 and is based in Denver, Colorado.
‘Chipotle’, ‘Chipotle Mexican Grill’, ‘Unburritable’, ‘Food With Integrity’, ‘Fresh Is Not Enough,
Anymore’, ‘The Gourmet Restaurant Where You Eat With Your Hands’, ‘Responsibly Raised’, and
various related designs and logos are the U.S. registered trademarks of the company.

Seasonal factors cause the company’s profitability to fluctuate from quarter (year ended December
31, 2016) to quarter. Historically, the company’s average daily restaurant sales and net income are
lower in the first and fourth quarters due, in part, to the holiday season and because fewer people
eat out during periods of inclement weather (the winter months) than during periods of mild or warm
weather (the spring, summer and fall months). Other factors also have a seasonal effect on the
company’s results.

2. Create an industry map:

1. Suppliers
2. Customers
3. Competitors/substitutes

Do any of the agents have economic power over the company?

Buyer’s Power: Buyers have many different options to choose from, so Chipotle has to make sure
their prices remain competitive to their competitors. However, buyers have little powers to influence
over the price. Chipotle’s price seems slightly higher than its competitors, but it’s still in a reasonable
range. Therefore, Buyer’s has a neutral purchasing power.

Supplier’s Power: Chipotle provides the freshest ingredients for their customers. There are only a few
farms that Chipotle thinks are acceptable and have the abilities to provide the best raw materials.
Due to the huge demand from the customers, Chipotle buys large amount of products from these
suppliers. Nonetheless, suppliers have neutral power.

Industry Rivalry: There are many other fast-food restaurants within the marketplace. The competition
is very intense due to the similar products each brand is selling. The industry rivalry is tremendously
high, so Chipotle should obtain competitive advantages by increasing product differentiation and
finding ways to raise customers’ brand awareness.

Threat of Substitution: The threat of substitution is high. Chipotle’s burritos and other products can
be easily substituted for another brand’s similar products. Customers can find other alternatives
easily and spend less money on similar products.
Barriers to Entry: The entry rate is very low because it has a high fail rate. The industry is already
extremely competitive so it’s certainly difficult for new brands strive to survive and achieve what
Chipotle has accomplished so far.

Thus, we have:

• Rivalry Among Competing Firms: (high)

• Entry of New Competitors: (low)
• Potential Development of Substitute Products: (medium)
• Bargaining Power of Suppliers: (neutral)
• Bargaining Power of Consumers: (neutral)

3. Estimate the company’s total available market

1. What is the industry’s organic growth rate?
2. Determine unit economics specific to the company

According to the new research, consumer foodservice sales grew 5.7 percent globally in
2015, improving on last year’s growth rate of 5.3 percent. Fast-casual dining was the
strongest growing segment across the industry at 10.4 percent, increasing USD $3.4 billion
from 2014 to 2015.

Fast casual grew at 10.4 percent, increasing USD $3.4 billion from 2014 to 2015, according
to Euromonitor.

4. Calculate the company’s (3 tiers of value):

1. No-growth NOPAT

No-growth NOPAT = avg. of previous three years NOPAT = $175.1 M

2. Invested capital

ROIC Analysis

NOPAT (EBITDA - Maint Capex - taxes)

ROIC = =
IC PP&E + NWC

2014 2015 2016

EBITDA $286,919 $311,705 $153,505
Maint. Capex (110,474) (130,368) (130,986)
Pre-tax 176,445 181,337 22,519
tax rate -37.6% -38.2% -40.8%
taxes (66,430) (69,312) (9,185)
NOPAT $242,875 $250,649 $31,704

PP&E $1,106,984 $1,217,220 $1,303,558

CA - CL 613,801 534,705 240,581
 Total IC $1,720,785 $1,751,925 $1,544,139

ROIC 14.1% 14.3% 2.1%

3. No-growth value of competitive advantage

No-growth value of competitive advantage = NOPAT/(Spread b/w ROIC and WACC)

= 175.1/(2.1% - 4%)

= -8,993 M

Earnings Power Value (EPV)

2014 2015 2016

Revenue $4,108,269 $4,501,223 $3,904,384
COGS (2,990,513) (3,326,936) (3,406,170)
Gross Profit $1,117,756 $1,174,287 $498,214
GPM 27.2% 26.1% 12.8%

SG&A $406,956 $410,698 $463,647

Operating Profit $710,800 $763,589 $34,567

OPM 17.3% 17.0% 0.9%

Interest Expense $- $- $-
Other Expense $- $- $-
Interest and other income, net $3,503 $6,278 $4,172
Income Before Taxes $714,303 $769,867 $38,739

Taxes $(268,929) $(294,265) $(15,801)

Rate -37.6% -38.2% -40.8%

Net Income $445,374 $475,602 $22,938

Free Cash Flow Maintenance

EBIT $710,800 $763,589 $34,567
Tax -38% -38% -41%
EBIT After Tax $978,410 $1,055,454 $48,666
Plus: D&A 110,474 130,368 146,368
Less: Capex Maint (110,474) (130,368) (130,986)
FCF Maint $978,410 $1,055,454 $64,048

FCF Maint $64,048

 WACC 4.0%
EPV $1,601,208
Shares Outstanding 29,770
Per Share $53.79

4. Market implied value of growth

Market implied value of growth = EV - IC - excess returns/i

EV:

Share Price (03/19/17) $414.88

Shares Outstanding (12/31/16 - fully diluted) 29,770
Market Cap $12,350,978
Less: Cash (12/31/16) 87,880
Plus: Debt (12/31/16) -
Enterprise Value $12,263,098

IC: 1,544 M(2016)

Excess return: CMG return (2016) = -21.37%

S&P TR 500 return (2016) = 11.96%

Excess return = -33.33%

Market implied value of growth = $12,263,098 - $1,544,139 - -33.33%/4%

= $10,718,966M

5. Explain the company’s source/s of competitive advantage

1. Are they sustainable?
2. Has there been market share stability in the industry?
3. Is the value you calculate in 4c supported by your answer to 5a?

Chipotle provides high quality Mexican food at a reasonable price, with a short weighting period.
They use naturally raised animals for their meat and place great emphasis on quality in the production
of all their products and services

The main competitive advantages that separate them from competition are:
 • Naturally raised meat in food (healthy)
• Unique flavor of high quality products
• They rank among the top in fast food customer services based on price, environment, meal,
and service.
• Very low marketing spend. Chipotle spends 1% of their total revenues on ads compared to
their larger rivals that spend 4% or more. They spend less in a year than MCD in 48 hours.
This is sustainable.
• Market to millennials
• Brand power
• Targeted product positioning

6. Governance
1. Evaluate senior management in terms of the company’s financial performance, its
vision/strategy, and historical capital allocation

CMG has efficiently invested its financial resources in buildings, projects, and equipment, resulting in
strong returns.

2012 2013 2014 2015 2016

Free Cash Flow 222.93M 328.85M 429.48M 425.90M 90.40M

Invested Capital 1.01B 1.23B 1.54B 1.78B 1.33B

Cash ROIC 22.09% 26.70% 27.84% 23.90% 6.81%

Over the past 5 years, CMG has generated strong profits with money shareholders have invested. This is
considered one of the best indicators of quality management.

2012 2013 2014 2015 2016

Net Income 278.00M 327.44M 445.37M 475.60M 22.94M

Stockholders' Equity 1.25B 1.54B 2.01B 2.13B 1.40B

Return on Equity 22.31% 21.29% 22.13% 22.35% 1.64%

CMG has been able to maintain profitability in good times and bad. This could mean CMG has an extremely
strong business or has the ability to scale down costs when needed. CMG has created positive free cash flow
for 9 or more of the past 10 years.

2012 2013 2014 2015 2016

Free Cash Flow 222.93M 328.85M 429.48M 425.90M 90.40M

2. Review management’s compensation. Is it reasonable and appropriate?

The management compensation is shown in the table below:

 We see that the compensation is not unreasonable and seems to be appropriate for the roles.

3. Evaluate the Company’s Board of Directors. Are they shareholder friendly and capable
of representing shareholder interests?

Board Members
Years on
Name Title Role Background Board
Ells, M. Steven Founder, Internal Founder and Ex CEO 1996-Present
Chairman and
Chief Executive
Officer
Baldocchi, Independent External Mr. Albert S. Baldocchi, also known as Al, serves as Consultant 1997-Present
Albert S. Director of Grace Venture Partners.
Flanzraich J.D., Lead Director External Mr. Neil William Flanzraich, J.D., is the Founder of Leviathan 2007-Present
Neil William Biopharma Group, LLC and serves as its Principal. Mr. Flanzraich
served as the Chief Executive Officer of Cantex Pharmaceuticals,
Inc. until February 13, 2017. Mr.
Flynn, Patrick J. Independent External Mr. Patrick J. Flynn, also Known as Pat, served as the President 1998-Present
Director of Reptron Manufacturing Services at Reptron Electronics Inc.,
since 1986. Mr. Flynn served as an Executive Vice President of
McDonalds Corporation until January 2001. He has over 30 years
of experience in the electronics business.
Cappuccio, Director External Mr. Paul T. Cappuccio has been an Executive Vice President and 2016-Present
Paul T. General Counsel of Time Warner Inc. since January 11, 2001. Mr.
Cappuccio oversees the worldwide management of Time Warner
Inc.'s legal functions, collaborating with all of its operating
businesses. Mr. Cappuccio has been Executive Vice President,
Secretary and General Counsel of Warner Communications LLC
since February 2, 2001.
Charlesworth, Independent External Mr. John S. Charlesworth serves as the Sole Owner of Hunt 1999-Present
John S. Director Business Enterprises LLC and EZ Street LLC. Mr. Charlesworth
served McDonald's until 2000, where he served as the President
of its Midwestern Division from July 1997 to December 2000.
Friedman, Independent External Ms. Darlene J. Friedman served as the Senior Vice President of 1995-Present
Darlene J. Director Human Resources at Syntex Corporation.
Gillett, Stephen Independent External Mr. Stephen E. Gillett serves as GV Advisor at GV. Mr. Gillett 2015-Present
E. Director served as the Chief Operating Officer and Executive Vice
President of Symantec Corporation from December 21, 2012 to
November 13, 2014. He served as an Executive Vice President,
President of Digital, Marketing & Operations and President of
Best Buy Digital & Global Business Services of Best Buy Co., Inc.
since March 14, 2012.
 Hickenlooper, Director External Mrs. Robin S. Hickenlooper has been a Vice President, Corporate 2016-Present
Robin S. Development of Liberty Media and Liberty Interactive Corporation
since January 2013.
Musk, Kimbal Independent External Mr. Kimbal Musk serves as a Chef-Owner of Kitchen Cafe, LLC. 2013-Present
Director Mr. Musk served as the Chief Executive Officer at OneRiot, Inc
(Alternavely Me.dium Inc.). Prior to OneRiot, Inc., he has been
involved in many young businesses.
Namvar, Ali Director External Mr. Ali Namvar serves as a Partner at Pershing Square Capital 2016-Present
Management, L.P. Mr. Namvar joined Pershing Square in 2006.
He has more than a decade of experience investing in publicly
traded, branded consumer products and restaurant companies.
Paull, Matthew Director External Mr. Matthew H. Paull serves as an Advisory Director of Pershing 2016-Present
H. Square Capital Management, L.P. Mr. Paull has significant
experience in the restaurant industry and financial expertise,
including deep understanding of financial markets, corporate
finance, accounting and controls and investor relations. He
served as the Chief Financial Officer of McDonald's Corporation
from July 2001 to January 2008 and Senior Executive Vice
President from July 2004 to January 2008.

As we can see half of the executives on the Board are long-standing supporters of CMG with more than
10 years on the Board. Each member has been a stalwart in his/her respective industry and thus, would be
largely can represent shareholder interests. There are two representatives from Pershing Square and one
from Grace Venture partners.

4. Review shareholder list. Do any of the large holders (management, former

management, private equity firms, activist funds, etc) have an agenda that should be
considered?

We have activist investors such as Pershing Square and Citadel LLC having a position. These
funds would be interested in unlocking shareholder value and would push CMG to return to path
of improved profitability.

7. Risk
1. Identify the primary sources of risk to your intrinsic value estimate

• Continuing decline in sales and profitability in the future

• Failure of international expansion and other outlets to add to revenue growth and profits
 • Food safety incidents such as E.Coli - CMG may continue to be negatively impacted by
food safety incidents associated with restaurants beginning in the fourth quarter of 2015,
and further instances of food- borne or localized illnesses associated with restaurants
would result in increased negative publicity and further adverse impacts on customer
perceptions of CMG brand, which would likely result in further declines in sales.


2. Does the company face any operational risks?

• Increased competition in the QSR space

• Business could be adversely affected by increased labor costs or difficulties in finding
and retaining top- performing employees.
• Changes in food and supply costs could adversely affect operations
• Failure to receive frequent deliveries of higher- quality food ingredients and other
supplies meeting specifications could harm operations


3. Does the company face any financial risks?

Since there is no debt, CMG has a strong balance sheet. However,

• Failure of international expansion could lead to losses

• Food scarcity may lead CMG to source ingredients at higher prices, affecting margins

4. Is the company exposed to any significant macro risks?

• Changing consumer preferences may lead to decline of sales

• Economic conditions with favorable available disposable income per capita
• Regulatory and Legal Risks -
Governmental regulation in one or more of the following
areas may adversely affect existing and future operations and results.

8. Next steps:
1. What would be the next steps in your research process?
2. What specific information would you try to find out?

In terms of next steps, I would like to look at the detailed projections of future revenue and examine
the path to sales and profitability more closely. I would also like to see different scenarios for
competitive dynamics that could come into play and plan for further expansion.

Overall, as we have seen the many reasons, including the ROIC trailing WACC, CMG is a candidate
for shorting. If one is invested, then the strategy should hold for the long-haul and wait out for at least
5 years to realize the changes being brought by CMG.