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The following post was prepared for a Bear vs Bull discussion on the CMG Rule Breakers boards.

CMG’s Question brings you Dueling Answers. Prepare for: “Da Bear!”

It is easy to look at Chipotle’s numbers and extrapolate them out to the future. It is so easy even someone too lazy to make their own lunch and too foolish to realise they are killing themselves could do it. Alas, the burrito they had for lunch may have made them too slothful to look closely at the figures, as there is absolutely no way Chipotle can continue to grow at its current pace. Come with me as we have a look to see if our delicious purveyor of death and budgetary deficit can continue its amazing growth.

Unwrapping Chipotle’s Hidden Costs:

Of the 300 million people in the US, 65% are overweight and almost half of those are clinically obese. Diabetes Type 2 is going to cost America 20 gazillion dollars and the knuckleheads in Washington are scratching their heads wondering how the heck they are going to pay for the associated increasing costs to health care. Hypothetically I could see it play out this way: Displaying their usual unimaginative penchant for revenue raising, the boneheads in Washington settle on a fat tax. Despite much lobbying by the purveyors of fat, in 2009 President Hillary Clinton signs into law the Take Away Tax Act which quickly becomes known as the “Take from the Portly Tax”. Its cornerstone is a 50% tax on the sale of all fast food containing more than 350 calories. Suddenly Selzhanik realises his burrito without guacamole, cheese, added salt and sugar doesn’t taste quite so good.

A Takeaway Tax may sound fanciful, but if you look at the societal costs of obesity it is clear something has to be done and whatever the solution it is likely to directly impact Chipotle’s growth. It has been estimated that the annual cost due to obesity in the U.S. is $122.9 billion. This estimate accounts for $64.1 billion in direct costs and $58.8 billion in indirect costs related to obesity. By far the greatest contributor to this amount is Type 2 Diabetes with osteoarthritis, heart disease and hypertension playing less than admirable supporting roles. The National Restaurant Association ( ) forecasted that fast-food restaurants in the U.S. would reach $142 billion in sales in 2006. As you can see, fast food actually costs twice as much as we pay at the cash register. Governments around the world woke up to the extra costs of tobacco years ago and they are now waking up to the real cost of fast food. Councils are already taking action. Witness New York City Council's ban on trans fats in restaurant foods and the requirement that fast-food eateries post calories for each offering in large type in prominent positions. Will the lines still be out the door when people see 1300 calories and 60g of fat on Chipotle’s menu?

What does any of this have to do with Chipotle and its growth? Weight gain and obesity are caused by consuming more calories than the body needs. Even Selzhanik’s healthy sounding burrito of rice, black beans, chicken, tomatoes, guacamole, cheese and lettuce will soon see him going up a pant size, . It contains a gut widening 1229 calories which is almost half a healthy person’s daily need and 52g of fat of which 13.5g is saturated fat. Then toss in some unhealthy sides of cholesterol and sodium. 3329mg of sodium and 5g of sugar no less. Gee I wonder why it tastes so good. Most dieticians suggest keeping your daily sodium intake under 2400mg and you only need 500mg, whoops a week worth of sodium in one meal! Yup it is delicious death wrapped up in the guise of natural, lean, organic, high quality fresh produce. These guys are killing you and they know it. They have picked up the tobacco’s industries playbook and are running all the same old plays with a fresh twist. They sell products with added fructose knowing that this interferes with our bodies natural “I’ve eaten enough” mechanisms. They add extra salt and sugar to make their food more addictive, not caring that they should be aiming to reduce these ingredients from the food they serve, while creating confusion with misleading advertising.

So what is the government currently doing? Running an advertising campaign is their main thrust and for some people it is possible to claim weight loss programs as tax deductions. Will advertising have an effect? Maybe in a generation or two when kids get tired of seeing their parents die young and sick of the constant tax hikes required for societies haemorrhaging medical costs.

Is the government likely to legislate? My Takeaway Tax idea is unlikely, but the fast food industry is in their cross hairs and they will find ways to contain it. If not government legislation or advertising perhaps the lawyers will act? These pettifoggers smell a big fat payday and they are going to keep banging away until no-one wants to sell anything with over 10 grams of fat.

Perhaps Oprah will once again champion healthy eating or people may realise that they are consuming themselves into an early grave. There are many possible antagonists that will conspire to slow the growth of Chipotle. Whether it be my fanciful Takeaway Tax, successful advertising, law suits, increasing health awareness, Council bans or Oprah, the message will start getting through. When the message is delivered Chipotle’s growth will slow. CMG’s high multiples ensure its share price will sink faster than an unhealthy pooh; it will be a stinky sinker! Even if their earnings double in the next three years, a multiple compression could easily see Chipotle’s shares trading hands at the same price as today.

With Chipotle there is more to be concerned with than healthy eating. There is no doubt Chipotle is a hot concept right now. You’ll get no argument from me on that score. Yet it is precisely because they are a hot concept and have grown so phenomenally that there is absolutely no way it can continue to grow at the same pace. Chipotle may be here to stay, but many people have thought that with other concept chains. Quiznos was a hot concept back in the mid nineties, anyone been to one recently? Fads come and go, that is why they are called fads. The three big chains that have continued to grow (Starbucks, McDonalds and Subway) are centered around entrenched dietary habits and two of them play a very heavy addictive hand. Hamburgers, coffee and sandwiches have all been part of our diet for longer than most of us can remember. They are not fads, they are staples. Burritos? Well they’re borderline staples at best. I say fad, but even if burritos were part of our regular diet Chipotle still couldn’t continue its blistering pace for the next 5-10 years.

Looking at the Numbers:

“Investors often project recent earnings trends too far into the future, failing to realize how quickly circumstances can – change do – change. When earnings growth slows, as it invariably does, this deflates the price / earnings multiple and causes a dramatic drop in the price of the stock.” Wise words penned by Jeremy Siegel in Stocks for the Long Run, and fair warning to investors in CMG.

CMG’s share price has at least five years of excellent growth already baked in so we better look to see if they can keep up the pace for 10 years. Take a look at the table below and you have to search hard to find any current growth metrics that CMG can maintain for the next 5-10 years. I can spot a couple and they’re good ones, cash flow and net income. Oh but that’s based on respective 15% and 10% growth rates, gee I guess I’ll throw that bone to the Bull. There are no other metrics which Chipotle can realistically maintain their current growth rates. That might be because the other metrics have already had amazing growth, but the question is, “Can CMG continue to grow at the current pace for the next 5-10 years?” With the figures below in mind it is clear that there is no way Chipotle can keep up their current pace and for the sake of bulging guts around the world I hope they don’t.

INDICATORS Growth Growth 5 year 10 year MCD SBUX Likely?
04-05 05-06
Income before taxes 395% 126% 4,041 239,088 4,166 906 No way
EBIT 392% 121% 3,609 190,099 4,568 906 No way
Operating income 408% 100% 1,984 63,488 4,445 894 No way
EBITDA 110% 72% 1,625 24,678 5,896 1,215 No way
Cash from ops. 95% 34% 445 1,912 4,342 1,132 Maybe
Total revenue 33% 31% 3,187 12,339 21,586 7,787 Maybe
Rev. CAGR since ‘02 42% 4,751 27,430 No way
Total fixed assets 22% 22% 1,430 3,915 31,810 4,258 Maybe
Cash flow 135% 15% 154 312 4,794 996 Yes
Total net income 518% 10% 66 106 3,544 564 Yes
Store growth since ‘02 26% 1,823 5,801 No way
Share price 71% 1,317 19,298 No way

Store Count 2002 2003 2004 2005 2006
227 298 401 481 573
31% 35% 20% 19% 26% CAGR

Whether you agree with my proposed risks and the multiple compression that will result, the numbers show that it is impossible for Chipotle to continue to grow at their current pace. The share price can not keep growing at 71% annually, just as most of their metrics can not maintain an increase of 30% plus. Yes Chipotle may grow at 20% or slightly more but let me remind you one more time, the question was “Can CMG continue to grow at their current pace for the next 5-10 years?” I see no way that you can agree with my esteemed combatant as his case is surely nothing but lean bull smeared in fat.

Special thanks to ogres-crypt for generously donating all the data used.
NYtimes abstract
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