Chipotle Financial Analysis

Elizabeth Gong Joelle Darby Alex Bunney Billy Lucas

Table of Contents
Executive Overview Chipotle Overview Industry Analysis Accounting Policies Balance Sheet Liquidity Ratios and Analysis Solvency Ratios and Analysis Profitability Ratio and Analysis Cash Flow Adequacy Ratio and Analysis Market Prospects Ratio Analysis Stock Comparison Competitor Analysis Buy-Sell-Hold Analysis Bibliography 3 4 5 7 8 9 13 15 18 20 22 24 26

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2

Executive Overview
Steve Ells Founder Chairman and Co-CEO

Monty Moran Co-Ceo

Jack Hartung Chief Financial Officer

Mark Crumpacker Chief Marketing Officer

3

Chipotle Overview
Chipotle is a chain of fast food restaurants specializing in burritos and tacos with an emphasis on high quality. Founded on July 13 1993, by Steve Ells, the chain has grown from 16 restaurants in Colorado to an international organization with chains located throughout the United States, Canada, the United Kingdom, Germany, and France. In 1998, McDonalds became a major investor in Chipotle and helped the company expand to 500 locations during the duration of its investment. Today, there are 1539 chains. Chipotle has found success by positioning itself as a fast causal dining establishment dedicated to serving high quality food to customers.

Chipotle Mexican Grill, Inc. 1401 Wynkoop St. Suite 500 Denver, CO 80202

Corporate Offices:

Burrito Burrito Bowl Crispy Taco Soft Taco Salad Chips and Guac

Products:

Chipotles industry, also known as Quick Service Restaurant (QSR), has a very strong presence in the United States. In 2012, there was a 5% growth in total value of sales, the largest growth the industry has seen since 2007. It is a highly competitive market with many different companies offering varying dining experiences. Burger King, Wendys, Subway, and McDonalds combined accounted for the top 30% share of sales with McDonalds maintaining its category-wide dominance with a 17% share. McDonalds has been the giant of the fast food industry for several decades, but Chipotle is beginning to challenge the classic fast food (Doctors Associates, inc. Owns Subway restaurants) dining experience. Chipotle has redefined the fast food industry by offering higher quality food that is still quick to serve. This is attractive especially in current times due to growing concerns of the negative effects on our health from fast food that are deep fried and high in fat. Chipotle offers a healthier fast food alternative that is especially popular with young people. Chipotle has seen immense growth in the past years. Its revenue has increased from $1.3 Billion in 2008 to $2.7 Billion in 2012, and in that same year earning profits of $278 Million. This suggests a prosperous future for Chipotle. McDonalds is viewed as one of its top competitors. McDonalds is the world's largest chain of hamburger fast food restaurants, serving around 68 million customers daily in 119 countries. Despite Chipotles rapid and immense growth over the last several years, it is still dwarfed by McDonalds 2012 total revenues of $27.6 billion and $5.5 billion profits. However, the companies arent entirely comparable as Chipotle was founded on July 1993 whereas the first McDonalds opened in May 1940.

Industry Analysis

YUM! Brands, owners of franchises such as Taco Bell, Pizza Hut, and KFC, are also a strong competitor in QSR. In 2012, their total revenue was approximately $13.1 billion. McDonalds and YUM! Brands embody the typical fast food products and environment while Chipotle takes on an innovative and new approach to fast food. Competitors like Panera have a similar focus on better quality while still providing quick service. Panera is still attempting to establish its presence in the market, and it has been successful thus far with $662 million in annual revenues in 2012. Subway, a privately owned competitor, currently has 40,859 locations worldwide surpassing McDonalds.

(In

The preparation of Chipotles financial statements is in alliance with the United States Generally Accepted Accounting Principles (GAAP). While all companies are expected to adhere to these principles in terms of managing and reporting finances, certain financial approaches are left to the discretion of the individual firm. Chipotle operates on the basis of seven regions within the company. All of the financial information from these regions is consolidated into one financial statement that eliminates any intercompany discrepancies with balances and transactions. Sales are recognized when product (food and drink) is sold to customers. Revenue from gift card sales is recognized as the gift card is used or as gift card breakage. Gift card breakage is the revenue gained through unredeemed, expired or lost gift cards. Many companies have eliminated the restrictions placed on gift cards such as expirations dates as it creates large uncertainty for revenue estimates. According to financial analysts, about 5% to 6% of purchased gift cards are not used, which is accounted for as gift card breakage at the end of year income statements. Chipotle defines cash equivalents to be any liquid investment that has maturity of three months or less. According to Chipotles annual report, Accounts receivable primarily consists of receivables from third party gift card distributors, tenant improvement receivables, payroll-related tax receivables, vendor rebates, and receivables arising from the normal course of business. Chipotle uses allowance for doubtful accounts by estimating bad debt expense for the period. Allowance for doubtful accounts is the companys best estimate of the percentages of credit sales that will be deemed uncollectible. Like most companies, Chipotle follows the Allowance Method rather than the Direct Write Off Method. The Allowance Method is the general standard for most companies as it aligns with the matching principle that recognizes revenue with incurred expenses of the same period. In order to determine an allowance for doubtful accounts, Chipotle uses a predetermined rate based on experience and observation. This percentage is then multiplied to either total credit sales or the ending balance of accounts receivables. Inventory is valued at lower of cost of market, and a first-in first-out inventory system is used. Like most food companies, Chipotle uses oldest inventory first since most of their products are perishable within a relatively short timeframe. In a period of inflation, this provides a higher taxable net income. Key ingredients are generally sourced from a small number of suppliers. Leasehold improvements, property, and equipment are recorded at costs that include costs associated with acquiring them and making them operational and profitable. Major alterations and improvements are capitalized to the companys balance sheet while standard upkeep and maintenance are expensed to the income statement. Useful lives of assets are reviewed minimally once a year and necessary adjustments are made accordingly. When assets are disposed of or retired, the necessary accounts are adjusted and any gain/loss is recorded. Chipotles depreciation of plant assets is calculated using the straight-line method. This creates a uniform depreciation expense throughout the estimated useful life of the asset. If the useful life of salvage value is different than initially anticipated, future adjustments are made. Leasehold improvements are amortized over the shorter of the lease terms, which includes the assets useful life.

Accounting Policies

Balance Sheet
2010 Assets = Liabilities + Stockholders Equity $1,121,605 = $310,732 + $810,873 2011 Assets = Liabilities + Stockholders Equity $1,425,308 = $381,082 + $1,044,226 2012 Assets = Liabilities + Stockholders Equity $1,668,667 = $422,741 + $1,245,926 2013 Assets = Liabilities + Stockholders Equity $2,009,280 = $470,992 + $1,538,288

Liquidity Ratios
Ratio
Current Ratio Acid-Test Ratio

Formula
Current Assets Current Liabilities Cash + Short term Investments + Current Receivables Current Liabilities Net Sales Net Avg. Accounts Receivable Cost of Goods Sold Average Inventory Purchases Average Accounts Payable Net Accounts Receivable x365 Net Sales Ending Inventory x 365 Cost of Goods Sold Ending Accounts Payable x 365 Cost of Sales Days Sales Uncollected + Days Sales in Inventory Days Payables Outstanding

2009
2.91

2010
3.30

2011
3.18

2012
2.93

2013
3.34

2.69

2.89

2.95

2.62

3.02

Accounts Receivable Turnover Inventory Turnover Accounts Payable Turnover Days Sales Uncollected Days Sales in Inventory Days Payable Outstanding Cash Conversion Cycle

361.27

352.35

323.14

216.86

157.52

89.59

88.28

92.28

89.06

88.94

19.01

19.09

18.49

17.00

18.27

1.01

1.04

1.13

1.69

2.32

4.07

4.13

3.96

4.11

4.10

19.20

19.12

19.74

21.53

19.98

-14.12

-13.95

-14.65

-15.73

-13.56

Liquidity Ratio Analysis

Liquidity ratios give insight into a companys ability to easily pay off short-term obligations. Companies and investors desire high liquidity ratios as it provides a higher margin of safety for a company to pay off liabilities. We included a vast range of liquidity ratios to depict an accurate picture of Chipotles ability to utilize its resources in order to meet current debt. The first two ratios are very similar in how they measure ability to pay off short-term debt. The only difference is what various investors and analysts identify as applicable assets. The current ratio includes assets that are to be employed within one accounting period. These assets typically include cash, receivables, inventory, short-term investments and prepaid expenses. The acid test ratio excludes prepaid expenses and inventory because they cannot easily be converted to cash. We began our analysis in 2009 to give better insight as to how the company has increased (or possibly decreased) its assets. From 2009 to 2010, Chipotle had a 13% increase in its current ratio. The following year, the company saw a slight decrease of 3.6% in its current ratio that would continue with another decrease of 6.2%. However, the next year Chipotle made an impressive comeback by increasing its current assets to current liabilities ratio by 14%. The acid ratio follows very similar trends with the exception of the 2012 fiscal year. During this time, while overall current ratios appeared to decrease in relation to current liabilities, the acid test ratio experienced an increase of approximately 2% suggesting that the overall decrease in the current ratio is most likely attributed to a decrease in inventory or prepaid expenses. The decrease in current ratio between 2011 to the end of 2012 can most likely be credited to the rapid growth Chipotle experienced during this time. With such high demand for expansion, Chipotle most likely had to take on more debt in order to create and establish new locations. The increase in the past year suggests that the new restaurants are beginning to turn a profit and paying off current debt. We next analyzed Chipotles accounts receivable turnover. Accounts receivable turnover evaluates a firms effectiveness to extend credit as well as collect debt. If maintained properly, accounts receivables are indirectly extending interest free loans to customers. Investors prefer to see a high accounts receivable turnover as it typically suggests the company either operates more on a cash basis or that they are able to efficiently extend and collect credit purchases. Chipotle has a relatively high accounts receivable turnover although it has been on the decline for the past five years. A decrease in accounts receivable implies that collection of debts is taking longer than in previous years. However as a restaurant, Chipotle would not typically have a high number of accounts receivable as most customers pay with either cash or a credit card (if this is the case, the credit card companies assumes the debt to be paid by the customer, not Chipotle). Thus, the decrease in accounts receivable turnover may be attributed to an overall downturn in the economy or specific industry. Inventory turnover depicts how frequently a companys inventory is sold and replaced in a given period. Inventory turnover can also be calculated as sales divided by average inventory, but this analysis used cost of goods sold (COGS) divided by average inventory. While both methods are acceptable, we calculated based on COGS because inventories are typically recorded at cost not market value. A low turnover is undesired as it implies poor sales and thus excess inventory, while a high turnover can imply one of two 10

things, high sales or inefficient buying. In essence, inefficient buying creates problems for the company as it means that the company frequently runs out of inventory and loses out on potential profit. It is a delicate balance as excess inventory suggests an investment of little to no return and possible losses should current market prices fall. Over the last five years, Chipotle has maintained a fairly steady inventory turnover with little variation. It is especially important for Chipotle to have an adequate inventory turnover because as a food service chain, most of their products are perishable within a few weeks. In order to maintain its strong inventory turnover, the company should be very cognoscente of trends in the market. For example vegetarian and vegan foods have become incredibly popular in our society over the last several years, and it does not seem to be ending anytime soon, so Chipotle must meet customers wants and demands. Accounts payable turnover measures the ability at which a company is able to pay off its suppliers and how many times during an accounting period it pays its average payable amount. It is better to have a higher accounts payable turnover because it shows how a company has a handle on its debt. An increasing accounts payable is a positive sign as it indicates a company is able to pay off suppliers off at a faster rate. Thus, investors do want to see decreasing accounts payable turnover as it indicates a company is taking longer to pay off a debt, and in the process, most likely incurring more debt due to accumulating interest. Chipotle had an overall steady accounts payable turnover although it decreased from the 2009 annual report until the 2012 report. This could suggest that Chipotle incurred more debt or had possible cash flow issues within those time periods, suggesting their assets were tied up in noncash equivalents such as inventory or short term investments. Typically the accounts payable turnover stayed within the 17-19% range suggesting it takes Chipotle on average anywhere from 19 to 21 days to pay off their average accounts payable (assuming a 365 day period), which is a relatively short amount of time. Days sales uncollected, or days sales outstanding, indicates how many days a company takes to collect after a sale has been made. It is in a companys best interest to keep the collection period short as it provides more cash to pay off debts or for future investment. As mentioned above, Chipotle most likely has little to none accounts receivables as most of transactions occur with cash or credit cards, and thus would have a extremely low days sales uncollected. Typically increasing days sales uncollected indicate that a company is taking longer to collect on debts. While this ratio did double over the last five years, the numbers are so insignificant it should not be a source of worry for investors. Even at the highest days sales uncollected, accounts receivable represented .64% of net sales. Days sales in inventory gives investors an idea as to how long it takes a company to turn inventory into sales. Typically, a shorter DSI reflects a companys ability to quickly turn inventory into sales and hopefully profit. Between 2009 and 2010 there was a 1.5% increase in DSI although Chipotle recovered with a 4% decrease which could suggest better product management or a more easily predictable demand. The next two years witnessed an approximate 3.7 increase, which could be attributed to poor inventory management, decrease in overall sales, or an external factor such as poor economic conditions. While there has been a, general influx of the days sales inventory, the numbers are generally low and within a reasonably steady range, suggesting strong inventory management within Chipotle. 11

Days payable outstanding is a companys average payable period, or how often it takes a company to pay off creditors, or in Chipotles case, their suppliers. DPO is a delicate balance within a company. On one hand, a company does not want to pay suppliers back quickly because it disrupts working capital and cash flow. A company does want to continuously decrease its cash source however, but they almost must be careful about paying within a timely period to stay on good terms with their vendor. A delay or fault of payment could compromise the relationship and thus hurt the quality of product the company offers. Additionally, many vendors offer pay period discounts as an incentive to pay off debts earlier. Not taking advantage of such an opportunity could result in the company paying more for its supplies than it needs to. Typically, vendors give companies a 30 day DPO, meaning companies have about one month to pay. This typically coincides with most inventories being used within one month. Chipotle has always stayed under 22 days DPO. Until this past year there has been a steady increase suggesting Chipotle was taking longer to pay off vendors. However this past year, there was a 7% decrease in DPO. While the company is staying under the typical 30-day period, the ratios tend to be on the higher end suggesting that if vendors were offering a pay discount period, Chipotle was not taking advantage of it. Finally we investigated Chipotles cash conversion cycle, a measurement of how long it takes in days for a company to convert its resources into cash flows. It examines how long a company needs to sell inventory, the amount of time needed to collect receivables, and how long the company is granted to pay its bills. The cash conversion cycle is extremely important in disclosing how quickly a company is able to convert cash into sales and transfer credit sales back into cash. Companies want to create as short of a cycle as possible so that less cash is tied up in inventories and accounts receivables. Chipotles CCC is rather interesting as it has been negative for the past five years, hovering between -13.56 and -15.73. As mentioned before, the lower the cash conversion cycle the better. A negative CCC is optimal and indicates that a company receives payment from its customers before it has to pay its lenders. At the end of the day Chipotle does not need to acquire massive inventory (nor should it as a restaurant) and can hold onto its cash for longer periods of time.

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Solvency Ratios
Ratio
Debt Ratio Equity Ratio Debt-toEquity Ratio Interest Coverage

Formula
Total Liabilities Total Assets Total Equity Total Assets Total Liabilities Total Equity Earnings before interest expense and income taxes Interest Expense

2009
.27

2010
.28

2011
.27

2012
.25

2013
.23

.73

.72

.73

.75

.77

.37

.38

.36

.34

.31

517.7

1093.4

776.4

N/A

N/A

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Solvency Ratio Analysis

Solvency ratios are used to measure a companys ability to meet debts and other obligations, both short term and long-term. The lower a solvency ratio is, the more likely that a company will be able to meet its obligations and pay off these obligations. To determine whether or not a company will be able to remain in business and pay off obligations, solvency ratios focus on the cash flow of a company rather than their net income. Debt ratio measures the extent of a companys financial leverage, which is found by comparing total debts to total assets. The higher the debt ratio is, the more leveraged a company is and the greater the financial risk it is to investors. From 2009-2013, Chipotle has maintained an overall static debt ratio with a slight decrease in the past two years. This indicates that they are becoming increasingly less dependent on debt and have slowly begun to build up their assets. The ratio indicates that approximately about a quarter of Chipotles assets are financed through debts. An equity ratio, also known as the shareholders equity ratio, is used to decide how much a shareholder would receive should a company-wide liquidation occur. There has been an overall increase from 0.73 in 2009 to 0.77 in 2013. A higher equity ratio is usually a reasonable indicator that Chipotle is in a better long-term solvency position, and there is less risk to the creditors to lose their share. With a higher equity ratio, Chipotle has a lower interest expense so they can invest this money into advertisement and marketing strategies such as the scarecrow campaign, expansions, and other outlets that allow growth within their company. The debt-to-equity ratio indicates the share of equity and debt that a company is using to finance its assets. A low debt-to-equity ratio indicates that a company has been more hesitant to finance its growth with debt. Chipotles debt-to-equity ratio has been slowly declining over the past five years as it drops from .37 in 2009 to 0.31 in 2013. This implies that Chipotle has been able to finance some of its obligations with their growing assets, such as cash, and relied less on obligations. Over the past several years, the decreasing debt-to-equity ratio suggests that Chipotle has been able to pay off some of its debt obligations. They are also better protected in the case of a struggling economy or personal decisions that result in loss of profits. However, low debt-to-equity ratio may also indicate that Chipotles may not be taking advantage of the potential profits that could be generated with the use of outside financing.

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Profitability Ratios
Ratio
Gross Margin Operating Margin Pre Tax Margin Profit Margin Return on Total Assets Return on Common Stockholder s Equity

Formula
Net Sales - Cost of Goods Sold Net Sales Operating income Net Sales Earnings before Taxes Total Sales Net Income Net Sales Net Income Average Total Assets

2009
69.31%

2010
69.44%

2011
67.45%

2012
67.38%

2013
66.60%

13.81%

16.02%

15.70%

16.87%

16.78%

13.45%

15.74%

15.41%

16.76%

16.63%

8.35%

9.75%

9.47%

10.18%

10.19%

14.20%

17.18%

16.88%

17.97%

17.81%

Net Income Preferred Dividends Avg. Common Stockholders Equity

19.13%

23.64%

23.17%

24.28%

23.52%

Book Value Shareholders Equity per Common applicable to common shares Share Number of Common Basic Earnings Per Share
Shares Net Income Preferred Dividends Weighted Avg. Common Shares Outstanding

$22.34

$26.09

$33.41

$40.07

$49.57

$3.99

$5.73

$6.89

$8.82

$10.58

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Profitability Ratio Analysis

Profitability measures how well a company generates a return on invested capital and earnings, relative to the sources of financing the company uses to create these returns and earnings. Generally, for most ratios, a higher ratio value relative to competitors indicates the company is performing well. Profit margin analysis provides a broad measure of a companys profitability in comparison to its own historical performance, competitor performance, and industry performance. Therefore, the four different profit margin ratios (profit margin, gross margin, operating margin, and pre-tax margin) can be utilized to identify trends in a companys earnings. Gross Margin measures the percentage of sales revenue that Chipotle maintains after incurring the direct costs associated with the companys main commodities. It is used to analyze how efficiently a company is using raw materials, labor, and manufacturing fixed assets to generate profit. The higher the gross margin percentage, the higher the companys ability to utilize sales to fund its costs and other obligations. From 2010 to 2011, there has been a 2% drop in gross margin and has been steadily declining since then. This could be indicative of an increase in costs incurred or a decrease in profits and sales. Even though gross margin percentage is on the decline that does not necessarily mean poor performance on Chipotles part. It could be attributed to a variety of factors such as increasing fuel cost and dedication to bringing higher quality products to consumers, which would often lead to higher costs. Operating Margin measures a companys pricing strategy and operating efficiency. It indicates what percentage of revenue remains after paying for variable costs of production. Companies strive for a high operating margin because it signifies their ability to pay off fixed costs and reach the break even point. Operating income is calculated by subtracting a companys operating expenses (selling, general, administrative) from gross profit. Operating margin fluctuates from nearly 14% to 17%. From 2009-2010, there is a 2.21% increase, while there was a slight drop from 2010 to 2011. From 2011 to 2012, there was 1.17% increase and a 0.9% percentage point drop from 2012 to 2013. Shifts in the operating income could be attributed to effectiveness of management decisions. For instance, between 2012 and 2013, Chipotle experienced its biggest drop in operating margin. During this time, the company struggled with maintaining its original vision and not conforming to a typical fast food restaurant. That year, they experienced lower profits than analysts had anticipated. Because of that, Steve Ells, founder and CEO, suggested implementing strategies that reflected that of their competitors such as McDonalds. Such strategies included advertising to increase driving traffic rather than brand orientation, adding drive-through windows and considering the addition of breakfast items. Profit margin tells that for every dollar a company sells, how much of that dollar is kept as profit. A higher profit margin indicates how well a company is managing its costs and 16

performing relative to its competitors. It reflects a companys ability to earn net income from sales. But when evaluating the profit margin, it is important to measure it compared to other competitors profit margin in the industry. Overall, Chipotles profit margin has been steadily increasing since 2009, which could be a result of heavy expansion. There was a slight insignificant drop 0.28% from 2010 to 2011, but this should not cause any major concerns.

Return on Common Stockholders Equity measures a companys ability to earn net income for owners. It discloses the profitability of a company by revealing how much profit a company generates with money shareholders have invested. There has been a 4.5% increase from 2009 to 2010, but it has been fluctuating between 23.17% and 24.28% between 2010 and 2013. The increase from 2009 to 2010 may have been a result of Chipotles efficiency in creating revenue on new investment. The management could have inadvertently caused the inconsistencies from 2010 to 2013, so this may not be the most accurate portrayal of a companys ability to earn net income from shareholders money. Profit margin and total asset turnover make up the two basic components of operating efficiency. They reflect the effectiveness of management because departmental managers are the most responsible for creating operating efficiency. A companys return of total assets (ROA) is a strong indicator of how profitable a company is relative to its total assets and provides insight as to how efficient managers are at utilizing its assets to generate earnings. ROA shows what earnings were generated from the invested capital. Investors desire higher ROAs because it shows that the company is earning more money on less investment. It is important to not analyze ROA by itself but rather comparatively to competitors ROA or previous years ratios. In 2010 Chipotle experienced a 3% jump in ROA from the previous year, a positive sign for management effectiveness. However, since the initial jump, ROA has fluctuated between 16.88% and 17.81%. Although this is not a significant fluctuation, investors should be aware of its implications, such as management inefficiencies. We next analyzed the book value per common share of Chipotle. Book value per common share is a measure used by a companys shareholders to determine the risk associated with each individual share once all debts are paid off. It also indicates the dollar value remaining for common shareholders after all assets are liquidated and all debtors are paid. Since 2009, Chipotles book value per common share has more than doubled, increasing from 22.34 to 49.57. This is an overall positive sign for Chipotle and reassuring for investors as it suggests a high return on common shares should the company face liquidation. However, investors should analyze book value per common share carefully as it does not provide the most insightful information of a company. Rather, it presents a direction for investors and can serve as a red flag as to whether or not stock prices are under or overvalued.

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Cash Flow Adequacy Ratios

Ratio
Cash Flow on Total Assets Operating Cash Flow To Sales Free Cash Flow Free Cash Flow/ Operating Cash Flow Short-Term Debt Coverage Capital Expenditure Coverage Price to Free Cash Flow

Formula
Cash Flow from Operations Avg. Total Assets Operating Cash Flow Net Sales

2009
29.19%

2010
27.77%

2011
32.28%

2012
27.15%

2013
28.75%

17.16%

15.75%

18.11%

15.38%

16.45%

Cash Flow From Operations Capital Expenditures Free Cash Flow Operating Cash Flow

143.5

176.0

259.9

222.9

328.9

55.04%

60.86%

63.22%

53.07%

62.20%

Operating Cash Flow Short Term Debt

2.55

2.35

2.61

2.25

2.65

Operating Cash Flow Capital Expenditures

2.22

2.55

2.72

2.13

2.65

Market Capitalization Free Cash Flow

19.34

37.55

40.61

41.49

50.27

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Cash Flow Adequacy Ratio Analysis

Cash Flow information can be helpful in evaluating a companys ability to meet its obligations, pay dividends, expand operations, and obtain financing. Chipotles cash flow on total assets can be used as an indicator of its earnings quality. The companys cash flow on total assets has stayed pretty constant over the last five years. Its cash flow on total assets has consistently been greater than its return on total assets, which suggests Chipotles earnings are of high quality because more of its overall earnings are realized in the form of cash, which can be used for expansion, paying off bills, and other activities. Chipotles operating cash flows to sales ratio gives investors an ideas of the corporations ability to turn sales into cash. Chipotle has been able to produce increasing operating cash flows and revenues over the past five years, and its operating cash flows to sales ratio has remained steady as a result. This reflects efficient operations management, and Chipotles ability to generate both consistent cash flow on total assets and cash flow to sales ratios makes it a good investment opportunity. Even though the overall trend in these two ratios over the past five years has been a decrease (29.19% to 28.75% for cash flow on total assets and 17.16% to 16.45 % for operating cash flows to sales), asset and sales growth have essentially paralleled growth in operating cash flows (some years fluctuating more than others), which means the company consistently has had cash on hand to pay suppliers, employees, shareholders, pay for operating expenses, and invest in capital. Chipotles cash coverage of debt and short-term coverage of debt ratios have also remained relatively consistent over the past five years and have trended upward, overall, from the beginning to the end of the five years. These increasing trends suggest a greater ability of Chipotle to cover short-term and long-term obligations with the cash generated from operations. Free cash flow represents the cash a company produces after laying out the money it needs to maintain or expand its asset base. Chipotles free cash flows continually increased, except for 2012, where it experienced a $37 M decrease, due most likely to the $46 M increase in capital expenditures the company made in 2012. This increase in capital expenditures is expected of a growing company like Chipotle, which consistently aims to expand its operation base. Chipotles 2013 free cash flow value is the highest of the five years, which is a positive sign that prior investments are paying off, and also a sign that Chipotle is financially flexible and has adequate funds to use for further expansion and acquisitions. Chipotles free cash flow to operating cash flow reaffirms this financial strength, and this ratio has also experienced an overall increase since 2009, with the exception of a decline in 2012.

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Market Prospects Ratios

Ratio
Basic Earnings per Share Diluted Earnings per Share PriceEarnings Ratio Price to Book

Formula
Net Income Preferred Dividends Weighted Avg. Number of Common Shares Profit Number of Shares Outstanding Market Price per Common Share Earnings Per Share Stock Price Total Assets Intangible Assets and Liabilities

2009
3.99

2010
5.73

2011
6.89

2012
8.82

2013
10.58

3.95

5.64

6.76

8.75

10.47

21.66

36.86

48.74

33.60

50.25

3.95

8.15

10.11

7.42

10.75

20

Market Prospects Ratio Analysis

Market prospect ratios provide a good overview of what the market (public) expects for a company and is useful for the analysis of corporations with publicly traded stock. Earnings per share is an extremely important in the determination of a companys share price and corporate profitability. In 2013, Chipotle Mexican Grille had a rather high earnings per share ratio compared to Mcdonalds, YUM! Brands, and Darden Restaurants. This indicates that Chipotle generated a considerable more amount of income per share than its competitors. Both basic and diluted EPS have increased continuously over the past five years (about 2.5x each since 2009), suggesting Chipotle has become more and more profitable and is continuing to increase the amount of money it makes for its shareholders. The earnings per share ratio, however, is often susceptible to manipulation due to accounting policies used and/or management decisions. In order to better evaluate Chipotles earning per share ratio, one has to look to Chipotles cash flows. The companys operating cash flow per share ratio, calculated as operating cash flow divided by the number of shares used to calculate EPS (528.78/31.02), is greater than its EPS ratio, suggesting that the companys earnings are of high quality because Chipotle is generating more cash than the income statement indicates. Chipotles price-earnings ratio has also steadily increased over the past five years as well, from $21.66 in 2009 to $50.25 in 2013. It is considerably higher than its competitors, suggesting investors are expecting higher earnings growth for Chipotle in the future. Again, since earnings per share is used as the denominator for the calculation of the priceearnings ratio, this ratio is also susceptible to manipulation. Yet, Chipotles cash flows suggest that this ratio reflects the companys true underlying earnings. Chipotle also does not issue dividends to its shareholders and uses it retained earnings for use in operation and expansion. One aspect investors should be wary about is Chipotles stock price, which is significantly higher than its competitors. The companys stock price has increased pretty consistently over the last five years, with the exception of a severe decline in 2012. In July 2012, Chipotle reported rising input costs alongside moderate sales in the first two quarters of 2012, discouraging many investors who had been heartened by Chipotles growth potential. Chipotle then approved a stock buyback program of $100 million that was conducted through the first quarter of 2013, which most likely boosted its stock price back up. This decision could have been made for a number of reasons, but it looks like Chipotle started this program as a way to artificially boost its share price back up to previous levels. However, this report should not be found too discouraging and overall, the market prospect ratios suggest that investors have faith in Chipotles future growth and earnings potential. However, these market prospect ratios should not be used as the sole factor in a buy/hold/sell analysis.

21

Competitor Comparison
Stock Comparisons
Chipotle (CMG) Market Value Earnings Per Share
$18B

McDonalds (MCD)
$95B

Yum Brands (YUM)

$33B

Panera (PNRA)
$5B

$10.46

$5.56

$2.36

$6.82

McDonalds Annual Summary Data (Millions)

Years
2010 2011 2012 2013

Sales
$24,074.60 $27,006.00 $27,567.00 $28,105.70

Net Income
$4,946.30 $5,503.10 $5,464.80 $5,585.90

EPS
$4.58 $5.27 $5.36 $5.55

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Yum! Annual Summary Data (Millions)

Years
2010 2011 2012 2013

Sales
$11,343.00 $12,626.00 $13,633.00 $13,084.00

Net Income
$1,158.00 $1,319.00 $1,597.00 $1,091.00

EPS
$2.38 $2.71 $3.38 $2.36

Panera Annual Summary Data (Millions)

Years
2010 2011 2012 2013

Sales
$1,542.49 $1,822.03 $2,130.06 $2,385.00

Net Income
$111.87 $135.95 $173.45 $196.17

EPS
$3.62 $4.65 $5.89 $6.81

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Competitor Analysis
Chipotle finds itself in a unique position because its direct competitors, Taco Bell and Qdoba, are privately owned. This makes it difficult on Chipotle because it cant compare themselves to its most direct competitors because their most prevalent information is not available to the public. Instead, we decided to compare Chipotle to the next three public companies it is directly associated with which are McDonalds, Yum!, Brand and Panera Breads. Yum! Brands own companies such as Pizza Hut, Taco Bell, and KFC. McDonalds is one of the leading competitors in the fast food industry and has a strong global presence. They are well established, and have been a dominant competitor in the fast food industry for decades. It is important to keep in mind that when comparing McDonalds and Chipotle, McDonalds has held a strong market presence for decades while Chipotle is just recently establishing its foothold in the industry. Yum! Brand embodies the more quintessential idea of fast food. It owns several entities and is the largest fast food company in terms of system units and is a Fortune 500 company. Panera, despite being only several decades old, is rapidly becoming one of the top competitors of the fast food industry. In 2005, Panera was listed as the hot growth company, which is a strong indicator that it will continue to prosper in the next few years. Panera stresses fresh produce and high quality food along with quick service and fast fine dining which is growing in popularity. This will work to their advantage but may pose as an issue for Chipotle as it is a strong and rising competitor with similar models. However, despite such fast food companies dominance in the industry, the new healthy living style is becoming a popular trend. As a result, this may generate potential reduction in sales and a decline in popularity of such unhealthy fast food restaurants. This will aid Chipotle in establishing a stronger presence in the industry and will allow them to prosper. Market value is market capitalization of a publicly trade company. Market value is calculated by multiplying number of outstanding shares by the current share price. This is usually a reasonable measurement of the business prospects of a company. Out of Chipotles competitors, McDonalds has the largest market value with an impressive $95 billion. Yum! Brand follows right after with $33 billion. Chipotle comes in third with $18 billion, and Panera is last with $5 billion. It is impressive that Chipotle has a relatively high market value since it has only been incorporated for less than a decade. The Earnings per share is the amount of company profits that is allotted to each outstanding share of common stock. EPS is considered to be a significant factor in determining individual price of each stock. A high EPS is favorable; however, it is important 24

to keep in mind that EPS might not be the best representation of true earnings and should also be compared with Return on Assets and Return on Equity. Chipotle has the highest EPS with $10.46 per share, which is the highest out of the analyzed competitors. In terms of its features, it may attract more investors because they stand a chance in receiving more profits if they invest in Chipotle. Yum! Brand has the lowest EPS with $2.36 per share. This may be a cause of concern for some investors and may threaten the strength of the company. Although they currently have the second strongest market presence and high revenue, their net income has fallen over the last four years. This can be attributed to increasing expenses due to recent scandals associated with poor quality of food, especially prevalent in Taco Bell. Overall poor advertising, the growing trend in healthy eating, and the highly competitive industry are all potential factors that could have led to increased expenses and reduced overall net income. Over the past few years, McDonalds has shown a steady increase in sales, net income, and EPS, all indicators of financial security. McDonalds is presumably the number one company in the quick service restaurant industry. As of right now, McDonalds will most likely hold its ground in the industry with strong marketing tactics, ability to adapt to changing trends, and current dominant stance in the industry. Panera has also shown a rapid increase in sales, net income, and EPS in the past few years. However, unlike McDonalds, it is still relatively new. Panera caters to a slightly different market due to its higher prices and different variety of food. Recently, they have overcome PR struggles regarding discrimination in the work force. Paneras growing popularity can also be attributed to its market strategy of being a community builder and a place for people to enjoy high quality food and interact with each other in a welcoming environment. They brand themselves as a much-needed opportunity to enjoy a break from todays fast paced world.

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Buy-Hold-Sell Analysis
After careful analysis, we have found that Chipotle is a strong company with a lot of future earnings potential. Chipotle provides a better alternative to the usual, unhealthy fast-food experience provided by most of its competitors. Its emphasis on high quality and natural products has caused it to become extremely appealing in a time where healthier dining habits are trending. Chipotle has grown immensely over the last decade, and although still dwarfed by giant conglomerates, such as McDonalds, which has had an established presence for half a century, Chipotle is still in the early stages of its growth. Chipotles financial position has become increasingly strong over the past five years. The company has taken on more debt over the past five years, which is expected of a company that is expanding at Chipotles rate. Although it took an initial hit as a result of this increased debt, Chipotle is continuing to get better at meeting its different financial obligations, as suggested by its different liquidity and solvency ratios. The companys cash position supports strong financial leverage as well, and Chipotles increasing operating cash flows and steady cash flow adequacy ratios suggest that the company has sufficient cash to finance expansion, pay off debts, and more. Chipotle has become increasingly profitable as well, over the last 5 years. Revenues have continually increased and have generally met investors expectations. One exception to this statement is that in 2012, Chipotle took a considerable hit due to increasing costs and moderate, unexpected revenue growth. This led to a considerable drop in share price and investor faith in the company. However, since then, Chipotle has bounced back and has increased its share price to record levels, and reinstalled investors faith in the company. Chipotles book value per common share, earnings per share, and price-earnings ratios all suggest that investors expect the company to grow in the future as well. However, investors should not be too quick to invest in Chipotle, as future growth is expected to start slowing down for a number of reasons. First, Chipotle generally always operates at its maximum capacity, making it difficult for the company to continue to increase revenues without simply opening new stores. Second, the type of Tex-Mex food that Chipotle provides is much more appealing in countries within North America than it is internationally, making it hard for Chipotle to expand its border further. Still, Chipotle is working to find ways to continue to expand and increase its profits. For example, Chipotle has started a catering service as an alternate source of revenue generation outside of the restaurants themselves. This catering service is still new and has not found its footing yet. Some of its competitors, like Panera and Qdoba, already have well-established and successful catering services, providing competition to Chipotles, but also providing encouragement to management that the catering service will eventually be successful. Another way that Chipotle has attempted to expand is through the Scarecrow advertising campaign. The feedback from this campaign has been mostly positive (there has been some backlash though from customers who believe these advertisements are misleading), and the campaign has contributed to an overall increase in customer-base. Yet, as with all high growth companies, Chipotle is not expected to be able to keep up its impressive rate of growth forever. In conclusion, we suggest that investors who own Chipotle stock should hold their stock, because there is still a considerable amount of growth that lies ahead in Chipotles future. However, we also recommend that if you do not already own the stock, do not buy it, as the companys stock price is considerably high compared to its competitors (over $500 a share). As

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seen in the second half of 2012, a failure of Chipotle to meet expectations even slightly could cause its share price to fall dramatically, and that point, we believe the stock is a better buy.

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Bibliography

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"Chipotle, Growth Slowing, Looks at Fast-Food Future." Bloomberg.com. Bloomberg. 14 Apr. 2014 <http://www.bloomberg.com/news/2012-10-25/chipotle-seen-becomingmcdonald-s-with-drive-throughs.html>.

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