The Strategy of Chipotle Mexican Grill - Coursework Example

Firm Prognosis Chipotle’s IPO was announced in 2006. From the Company’s 10k report, Chipotle expected to open 180 to 195 restaurants in Its average sales by December 31, 2013 were at $ 2.169, an increase from $ 2.113 of the year 2012; a 5.6% increase. This was contributed by increased customer visits. Packaging, Beverage, and food costs increased proportionally as percentage of revenue, in 2013, as result of inflation in ingredients. The inflation is expected in 2014. In 2013, percentage operational cost increased in comparison to revue as result of high expenditure when advertising. In terms Dollars in 2013, is as a result of increased benefits costs and payroll; this is attributed by increased legal cost and growth. Chipotle is affected by the seasonal factors. Net income and daily sale, historically, have been lower; few people eat out at winter, and restaurants near academic institutions hit low during recess. Chipotle operates its businesses in leased premises. Chipotle Mexican Grill, Inc, among 5 year Cumulative Total Return of S & P Restaurant Index, and the S & P 500n Index Chipotle Mexican Grill, Inc S & P Restaurants S & P 500 *100 USD invested on December, 31, 2008 in index or stock, including reinvestment of dividends. Analyst Report From the recent Value Line Report, Chipotle Mexican Grill, CMG, recently announced a relatively steep bottom-line decrease and saw its stock run at of 16%. CMG shares are trading at near all-time highs. CMG reported earnings of $2.66 per share, which was short of Value Line’s approximation of $2.75. The $2.66 corresponded to a year-over-year progress of 17%, underachievement of this magnitude is usually sufficient to send investors packing. Contrary, revenue advances kept investors interested and doubled. The top line climbed by 18%, to a figure of $826.9 million, which was 1% improvement. Within the stores sales gains were excellent, at 6%, which was high as compared to the forecasts of a 4%. CMG’s investors are excited due to: Increased same store sales amid tough economic times effective advertisement in the mainstream media Introduction of catering services The earnings are not clear, but analysts are looking a 20%-plus share-earnings increase this year. Current food expenses have increased considerably, due to increased produce (tomatoes, tomatillos and corn) prices, chicken and higher dairy prices, and escalated oil (rice bran and sunflower) prices. The input costs pressures are unlikely to reduce, and will possibly weigh down margins through the year 2014. CMG has come out profitable, but it is tough to recommend their stock at the current levels, because their P/E is over 47x; this is very high despite its high-growth. P/E According to Morningstar, CMG provides customizable menu which consists of organic and naturally raised products, and aesthetically attractive restaurant designs; this is basis for narrow moat rating. These have led to high level margins and sales in tough economic times, faced by most restaurant operators. Additionally, CMG sources from local farmers and ranchers, this has led to continued growth with profitability, and excessive economic returns. In the financial year 2013, CMG made $3.2 billion in sales. CMG is a dominant stake holder in the $35 billion-plus domestic fast-casual restaurant business category. CMG can outpace its rival fast-food-casual peers, if the chain matches the density of home market, Denver. CMG’s fair value estimation is about $600 from $570 as a result of modest increase in operating margin and near-term revenue growth outlook proportional to recent comparable traffic trends. The updated fair value for fiscal 2015 price/earnings is 33 times, while the enterprise’s value/EBITDA is 17 times, finally a prediction of free cash flow result of 2%-3%. A top-line percentage growth of 28% is anticipated during 2014. Observing the managements guidance, of 2015, calling for the opening of 190-205 restaurants and reduced-single-digit food cost inflation , in relation to third-quarter levels, is realistic and in line with the model. The leverage present in CMGs restaurant model is impressive. Margins exceeding 30%, within five years, are expected when compared with 26.6% of 2013; the will position CMG on the top position against all industry operators. Operating margins of 17.4% are formulated, for 2014, as compared to 16.6%, of 2013, from the model. This is driven by restaurant’s margin gains, despite being tempered by an increased marketing cost. A margin expansion is expected, dependent on the rollout of the G&A expense leverage and "A model" low-cost restaurant prototype. The model formulates an operation margin improvement to 22% in the next five years. Capital leases and ROIC will improve to mid-20% range as to compared to postulated 10.0% cost of capital assumption hence reinforcing the narrow economic moat rating. CMG faces significant risk such as: Quick-service chains are improving their decor and menus Casual-dining joints are focused on improving their value proposition CMG faces market saturation Demographic shifts have increased meals prepared at home Food, energy, occupancy, and labor cost volatility can disrupt results Mergent Online has reported that the company’s management has been opportunistic in repurchasing share, of $622 million at an average price of $153 per share) for the past five years. In addition, GuruFocus.com reports that for the past two years CMG has suddenly increased by 142%, as its stock becomes an outperformer. CMG released its third quarter results on October 20, 2014 which points at a strong growth. From previous year’s quarter, the CMG’s revenue increased to $1.08 billion, which is 31.1% increase. Diluted earnings per share were at $4.15, hence representing a sharp growth of 56.9% in comparison to the 3Q13. By September 2014, EPS increased by 29.8%, that is, $10.29. CMG has maintained strong growth momentum via the quarters as the EPS growth accelerated, in the third quarter of the year 2014. Asset Turnover shows how quick a CMG turns over its asset via sales. Asset Turnover is obtained from the division of Revenue by Average Total Asset. CMG Revenue for past three months, ending in September, 2014 is $1,084 Million while Average Total Assets $2,357 Million. Therefore, CMGs asset turnover for the quarter is 0.46. CMGs Return on Equity (ROE) for the quarter is 28.69%. ROE is related to Return on Assets (ROA) when Du Pont Formula is used; ROA is 22.19%. Earnings Per Share Intrinsic Stock Price Model Revenue Growth Analysis Chipotle’s growth analysis is consists of revenue growth from new opened stores, and revenue growth in old outlets. The annual average is at 23%, 8% form old outlets while 15% from new stores. Damodaran Gordon Growth Model This is the output from the Gordon Growth Model Firm Details: from inputs on prior page Current Dividends per share = $0.00 Cost of Equity = 7.90% Expected Growth rate = 5.00% Gordon Growth Model Value =   0 Growth rate Value 5.00% $0.00 4.00% $0.00 3.00% $0.00 2.00% $0.00 1.00% $0.00 0.00% $0.00 -1.00% $0.00 -2.00% $0.00 -3.00% $0.00 The stable CMG valuation model availed by Damodaran is the worst model to use to value CMG going forward, because of missing values, that is Earnings per ratio and payout ratio; CMG does not offer dividends. Cost of Capital WACC is calculated from the product of capital structure components with their individual cost per component. Costs of debt are adjusted through multiplication by one with subtraction of the marginal tax rate. The Cost of equity is obtained from multiplication the number of outstanding shares times market price per share. WACC=wdRd(1 – tax) + ws(Rs) WACC (Weighted average cost of capital), proportion of equity (ws), proportion of debt (wd), marginal cost of debt (Rd), marginal tax rate (tax), and marginal cost of common stock equity (Rs). The proportion of equity and debt are market dependent, cost of debt is the outstanding number of bonds multiplied by the number of bonds. The returns from maturity of outstanding debt are the cost of debt. Cost of debt is usually reduced by amount of tax shield. COST OF CAPTAL Beta (B) 0.90 Risk Free Rate (Rf) 10 year US T-Bond 2.50% Pre-tax Cost of Debt (Kd) 3.40% Cost of Equity (Ke) 7.90% Market Risk Premium (Rm) 6.00% Shares Outstanding 31.083 Current Market Share Price $532 Market Value of Equity (E) $16,536.162 Debt Value Lt (Cap. Lease) $3.386 Debt Value ST (Cap. Lease) $0.143 Debt Value (Cap. Op. Lease) $2,206.481 Total Debt (D) $2,210.010 Enterprise Value (V) $18,746.172 Weight of Debt (D/V) 11.79% Weight of Equity (E/V) 88.21% Marginal Tax Rate (Tmar) 39.20 After Tax Kd 2.1% WACC 7.21% The following formula was applied: WACC= Kd * (1-Tm)* + *ke Cost of Equity Obtained from Capital Asset Pricing Model’s core variables: Beta (B), Expected return from market [E(Rm)]], and Risk free rate (Rf) E(Ri) = rf + βi [E(Rm)] - rf] Risk Free Rate This is dependent on Us Treasury bond Beta Estimate Raw beta is obtained by: Rit = αi + β­iRmt + εit Chipotle’s low debt ratio with the unlevered beta for the industry, led to a low beta as compared to its peers. Best beta estimate was from Bloomberg estimates. Market Risk Premium: Difference between expected return on market and risk free rate return is CAPM’s definition market risk premium. Damodaran’s estimate of about 6% was chosen After Tax Cost of Debt: Tax of debt is utilized when calculating WACC. Chipotle has not borrowed from any bank, their debts are on leases. Model Estimates Enterprise Value : Chipotle’s non-operational assets is made up excess cash, its operating cash is 2% of revenue while the remainder is excess cash. Continuing Value: Continuing value at the commencement of year 2024 is calculated from: CV = NOPLATt + 1 [1 – (g/RONIC)] / [WACC – g] g: The anticipated growth in NOPLAT NOPLATt + 1: Estimated NOPLAT for the years 2024 WACC: Weighted average cost of capiatal RONIC: Expected return on newly invested capital, at the commencement of ROIC of 2024 Nonequity claims and Value Debt: Chipotle’s operational leases and employee stock make up Nonequity claims and Value Debt. Employee option was estimated by Black-Scholes as recommended by Damodaran. From Chipotles December, 2013 10-k, a risk free rate of 0.5% was used. Cost of debt was calculated using default premium and risk free rate. Chipotle’s default risk rate was placed at 1% and risk free rate at 3.5% by Bloomberg, hence a total of 3.5%. Hence the cost of debt was placed at 3.4%. Value commodity equity:Subtraction of the all enterprise’s non-equity claims gives the value of equity. Share price estimation is calculated via the division of equity value by the company’s current number of outstanding shares. Forecast Three Weighted Averages of different future scenarios are used in estimating profitability margins and revenue growth. Chipotle’s forecasted share price is estimated at $621.70. Free Cash Flow When using P/E ratio alone, one might conclude that the stock is overvalued; Free Cash Flow analysis valuation technique helpful before arriving to a conclusion, that obtaining stock price whether it is correctly valued or not. Growth rate (g) Two-stage growth is used, for 5 year short term growth rate with an assumption that CMG will decline at long term of 5.6% growth rate. From the company’s annual report, CMG has no dividend, hence average ROE will be used as a proxy; for the next 5 years growth. 2009 2010 2011 2012 2013 ROE 18.03 23.80 23.08 23.06 23.71 Average = 22% ROE indicatesthe rate of return invested money for common stock owners in CMG hence ploughed back due to previous profitable years. This shows companys ability to make profits from shareholders equity, which is asset minus liability or the net assets. ROE illustrates how a company utilizes investment funds in order to generate growth. ROE is important when comparing profitability of different companies within a given industry or sector. Computer Required Rate of Return (r) Capital Asset Pricing Model will be utilized: R = Risk free rate + (Beta Market X Risk Premium) Risk free rate = 2.50% Beta (β) = 0.90   Market Risk Premium = 6.0% (Damodarans ) R = 0.035 + (0.9 X 0.06) = 8.9% Free Cash Flows Free Cash Flow for the year 2013, after that, growth rates can be multiplied to get the cash flow of the subsequent 5 years and the terminal value. CFO 528,780 -Fixed Capital Investment 199,926 +Interest after tax 1,180 FCFF $ 330,034 Cash Flows 2014 2015 2016 2017 2018 FCFF 380,852 457,022 548,427 658,112 691,017 PV of FCFF 315,764 345,021 376,990 411,920 14,324,577 NB: 14,324,577 is the terminal value, assuming the firm will grow at the constant rate forever, using geometric progression. Value of equity: If Present Value of FCFF are summed = $15,774,271, then subtracted subtract the 2013 liabilities in to obtain the value of the equity. Value of firm: $15,774,271 - liabilities: 1,033,784 = Value of equity: 14,740,487 Value of shares: Chipotle’s shares outstanding are at around 31.7 million. Value of equity is divided by the number of shares hence obtaining the value of each share. = $14,740,487/ 31,700,000 = $ 465 x share From the above analysis, CMG is overvalued; CMG has a current price of $654.28. Equity Value From GuruFocus.com, CMG’s value per share is $61.05 as at September 2014. For the past 12 months, CMGs average Value per Share has grown by 28.90%, while has seen a 23.80% growth per year 3 years and growth of 22.40% per year for the past 5 years. The highest 3-Year Value per Share growth rate for CMG was 23.80% per year. As of today, CMGs share price is valued $659.40, and then its Value per Share in September 2014 is $61.05. Therefore, CMGs P/B Ratio for today is 10.80. For the past years, the highest recorded P/B Ratio of CMG was 12.01 while lowest at 2.05; and median was 6.84. CMGs Value per Share for the year ended in Dec. 2013: Value Per Share = (Total Equity –Preferred Stock)/Total Shares Outstanding = (1538 –0)/31 =49.57 CMGs Value Per Share for September 2014: Value Per Share = (Total Equity –Preferred Stock)/Total Shares Outstanding = (1894 –0)/31 =61.05 Theoretically, this what CMG’s shareholders will receive if liquidated. Total equity is obtained from balance sheet and is equal to the total assetsless sum liabilities of a firm. References Thats WACC!beta. (2012). Retrieved November 20, 2014, from http://thatswacc.com/ GuruFocus.com, LLC. (2014, October). Retrieved November 17, 2014, from http://www.gurufocus.com/term/turnover/CMG/Asset%2BTurnover/Chipotle%2BMexican%2BGrill%2BInc Morning Star. (2014). Retrieved November 20, 2014, from www.morningstar.com Value Line. (2014). Retrieved November 20, 2014, from www.valueline.com/ Yahoo Finance. (2014). Retrieved November 17, 2014, from https://finance.yahoo.com Damodaran, A. (2014). Damodaran Online. Retrieved November 17, 2014, from http://people.stern.nyu.edu/adamodar/ NASDAQ. (n.d.). Retrieved November 18, 2014, from www.nasdaq.com Y Charts. (n.d.). Retrieved November 17, 2014, from www.ycharts.com Read More