Choppy seas ahead for Chipotle or Just Plain Sailing?
Throughout this Analysis I will Focus on the Strength of Chipotle at a time of high inflation: a tight labour market combined with the larger macro trends regarding the ‘great resignation’ and an impending recession. How is Chipotle holding up and how are management handling this environment? I will highlight what I consider good and bad from the company and more specifically whether I agree with the direction management are taking.
Health of the Restaurant Industry:
In order to get an understanding of the current headwinds facing Chipotle it is important to assess the current condition of the restaurant industry. The most significant factors can be seen in the bellow image1 from which several shall be discussed; this will be blended with additional data to give a detail view of the restaurant industry and how Chipotle has performed in comparison overall.
The three fundamental factors which have been plaguing the restaurant industry include: inflation, supply chain breakdowns and staff shortages. Inflation and supply chain breakdowns are closely intertwined. The issues were long apparent well before the Russian Invasion into Ukraine. Annual inflation increased to 4.7% in 2021 which is 235% higher than
1 State of the Restaurant Industry 2022 (2022). Available at: https://restaurant.org/nra/media/research/reports/2022/soi2022-summary.pdf (Accessed: January 3, 2023)
the 10-year trend of 2%2; for reference the second highest year of inflation goes back to 2011 where it hit 3.2% making 2021 almost 47% higher than the second highest point of reference in that 10-year range3. However, the inflection point resulting in the dramatic increase in inflation goes back to March 2020 when the world suddenly shut down as a result of the Corona Virus. A sudden decrease in demand and the uncertainly over the severity of the virus resulted in many supply chains significantly decreasing output. This has been slow to come back despite demand returning with a vengeance when the global economy started to reopen. Return of demand ran head on into low output supply chain. Increase in demand over supply has ultimately resulted in price increases.
The increase in supply costs has resulted in restaurants having to cutback menus, reducing optionality and portion sizes. This is compounded by supply chain delays making it difficult or impossible to get the required goods in to offer certain products4. With this in mind, the desirability for consumers to part with their well-earned (and now less valuable) cash has decreased since the start of the pandemic.
However, staff shortages have become an issue equal to that of inflation and supply chain breakdowns. Within the US 70% of restaurants were short staffed and half had staffing as their top priority in 20225. A knock-on effect of restaurants being shut down and uncertainty within the industry caused many individuals to leave. This coupled with the requirements of personal protective equipment making the job much less enjoyable have caused individuals to seek employment elsewhere. This is not limited to the restaurant industry with many people reflecting on life during the lockdown and deciding to leave their pre-lockdown jobs to pursue other endeavours. A dissatisfaction with work-life balance has made many employees resign voluntarily and accelerated over 2021 in a movement known as the ‘great resignation’6. With restaurant positions often considered lower skilled work pay is often low and their ability to leave is frictionless making retention difficult as can be seen by current job openings in the restaurant industry which is only going to get worse over the coming years7. This is reinforced by data coming out December 2022 showing that eating and drinking places are still 450,000 employees below pre pandemic levels, and the most widely impacted category are family diners and fast causal restaurants8
2 Consumer Price Index, 1913- (2022). Available at: https://www.minneapolisfed.org/about-us/monetarypolicy/inflation-calculator/consumer-price-index-1913- (Accessed: January 23, 2023)
3 46.875% increase over 2011 inflation data.
4 State of the Restaurant Industry 2022 puts delays due to supply chain issues at 96% and the change in menu offerings (usually leaner optionality) somewhere between 66% and 80%.
5 State of the Restaurant Industry 2022 (2022). Available at: https://restaurant.org/nra/media/research/reports/2022/soi2022-summary.pdf (Accessed: January 3, 2023)
6 Klotz, A. (2022) The Great Resignation Is Still Here, but Whether It Stays Is Up to Leaders. Available at: https://www.oecd-forum.org/posts/the-great-resignation-is-still-here-but-whether-it-stays-is-up-to-leaders (Accessed: January 12, 2023).
7 State of the Restaurant Industry 2022 (2022). Available at: https://restaurant.org/nra/media/research/reports/2022/soi2022-summary.pdf (Accessed: January 3, 2023)
8 Grindy, B. (2022) Total restaurant industry jobs. Available at: https://restaurant.org/research-and-media/research/economists-notebook/economic-indicators/totalrestaurant-industry-jobs/ (Accessed: January 7, 2023)
Finally, there has been a move to online transactions, an increase in personalisation and development of a digital experience for customers9. This was accelerated over the course of the pandemic with many restaurants’ being forced down digital channels. Examples of this can be seen in meal subscription programmes, DIY meal kit and take-out and delivery options – all of which are a must for many younger individuals. Despite the negative impact caused through lockdowns many restaurants’ have adapted to a digital experience for customers which has conditioned customers and is here to stay despite the economy reopening. 70% of millennials supposedly rely on meal prep and they also want takeout and delivery options10. There has been an overall blurring on the lines between the restaurant and home experience with many brands now representing young individuals’ overall food experience. This would suggest that the increase in the digital experience gives restaurants a unique opportunity to become even more connected with their customers and, in turn, extract more value based on their brand and food quality. However, this new opportunity remains difficult with 52% of independent restaurants unable to make rent payments in November 202211. It may well be that only the strongest brands survive with reliance on digital experience being paramount going forward and as younger individuals become more intertwined with technology.
How has Chipotle Fared?
Whilst this report does not serve as a detailed company analysis, it will break down fundamental areas of the business that relate to the above.
With the rise of the digital experience many customers must feel connected to the brand they are purchasing from. Therefore, brand is essential – post-pandemic more than ever. Chipotle is known for its focus on food with integrity: food that is clean, natural and grown responsibly. It is clear that Chipotle’s brand mission resonates with many in America as it has been able to expand its restaurants to over 300012 with an intention to expand to 600013. Management has no plans on changing its strategy and has continued to push for its brand with integrity making more inroads into natural, fresh drinks such as with its stake in Tractor Beverage Inc14
9 Generational divide may reveal emerging restaurant trends (2022). Available at: https://restaurant.org/education-and-resources/resource-library/generational-divide-may-revealemerging-restaurant-trends/ (Accessed: January 7, 2023).
10 ibid
11 Kelso, A. (2023) More than half of independent restaurant owners couldn’t pay December rent. Available at: https://www.nrn.com/finance/more-half-independent-restaurant-owners-couldn-t-pay-december-rent? utm_source=social&utm_medium=rss&utm_id=nrn (Accessed: January 4, 2023).
12 3090 as of the Q3 Chipotle 10-Q 2022: : Chipotle Mexican Grill (2022) FORM 10-Q, SEC Filings (chipotle.com) (page 5).
13 Klein, D. (2021) Chipotle, Drive Thru, and the Path to 6,000 Restaurants. Available at: https://www.qsrmagazine.com/fast-casual/chipotle-drive-thru-and-path-6000-restaurants (Accessed: January 15, 2023)
14 The Collaboration Between Chipotle and Tractor Beverage (2020). Available at: https://www.drinkpreneur.com/beverage-industry-news/brand-news/the-collaboration-between-chipotleand-tractor-beverage/ (Accessed: January 15, 2023).
Whilst the brand has held up well throughout the pandemic with management pivoting the company towards its digital channels15 the move to push price increases onto customers to offset inflationary pressures may start to bite. Year over year (Q3 2021 – Q3 2022) prices have been increased +13%; this has resulted in a 1% decline in year over year transactions16 , and same-store traffic growth was negative for the eighth consecutive month in October17 Whilst overall transactions and traffic declining the restaurant industry has continued to see increases in consumer spending despite record high inflation with +0.9% increase during November 2022 whilst the broader retail sector decreased by -0.8% over the same period18 This comes at a time when many economies have recession looming around the corner with inverted yield curves foreshadowing the inevitable. Central banks have even warned that a recession is coming19. With all this in mind has Chipotle overstepped and increased far too much when consumers are feeling the pinch or is Chipotle simply a leading indicator of the data so far released driven by the fact, they have a high price point?
Management has shown little concern with the price increases rolled out during 2022 stating that pricing is still competitive and that consumers are not changing habits in store20 . That said, it has been recognised that pressure has mounted due to increased costs with low-income customers dropping off21. Another likely reason Chipotle has not seen warning signs due to high increases is that almost all brands are running negative transactions
15 Klein, D. (2021) Chipotle, Drive Thru, and the Path to 6,000 Restaurants. Available at: https://www.qsrmagazine.com/fast-casual/chipotle-drive-thru-and-path-6000-restaurants (Accessed: January 15, 2023): ‘174% increase in 2020 compared to 2019’.
16 Machine, W. (2022) Chipotle: Priced To Deliver Mediocre Returns. Available at: https://seekingalpha.com/article/4562302-chipotle-stock-priced-for-mediocre-returns (Accessed: January 3, 2023).
17Dart, T. (2022) Chipotle: Aggressive Pricing Could Backfire. Available at: https://seekingalpha.com/article/4560970-chipotle-aggressive-pricing-could-backfire (Accessed: January 3, 2023).
18 Grindy, B. (2022) Consumers boosted their restaurant spending in November. Available at: https://restaurant.org/research-and-media/research/economists-notebook/analysis-commentary/ consumers-boosted-their-restaurant-spending-in-november/ (Accessed: January 5, 2023)
19 Find Link to the BoE stating this
20 Borsa Earnings Call, Chipotle Mexican Grill Q3 2022 Earnings call. Time of reference: 23.00 (Accessed: January 20, 2023)
currently22. Personally, I see this as a worrying trend if same store sales are expected to increase23; revenue growth is likely to come from price increases and is likely the reason eating and drinking sales have increased in the above image. Chipotle has also mentioned that their restaurant traffic has a large proportion of high-income customers (those earning north of $75,000) which is another reason why Chipotle has held up so well over 202224 . However, this may be pressured going forwards in 2023 as high-income individuals have started to change habits as the squeeze on earnings increases: this has been demonstrated by value chains such as Walmart who have stated higher income customers are shopping with them more often25. We may be at the inflection point where high-income customers are now having to transition to cheaper alternatives mainly caused by inflation and decreased discretionary income. Restaurant spend may well have had an extended runway due to customers running up debt to maintain their standard of living as seen before the spike in inflation – however this is an unknown26
Impacts of the Great Resignation and Move to Digital
If there is one thing Chipotle management have got correct it is their drive towards digital. This was executed well back in 2020 as digital sales increased 174% compared to 201927; this was backed up in Q2 2020 when digital was stated as being almost 50% of sales and almost half was order ahead28. Their digital app (Chipotle Rewards) has grown into one of the biggest loyalty programmes in the restaurant industry with 30 million users, and comes with
21 Borsa Earnings Call, Chipotle Mexican Grill Q3 2022 (Accessed: January 20, 2023) continuing to see pressure on the low-income consumer (Time of reference 21.45); facing macro headwinds from a lower income consumer (Time of reference: 37.46); had some lower income consumers drop away (Time of reference: 50.20).
22 Unsure as to whether this refers to fast casual specifically; Borsa Earnings Call, Chipotle Mexican Grill Q3 2022 (Accessed: January 20, 2023) Earnings call almost all brands are running negative transactions right now (Time of reference: 43.20).
23 Chipotle: Priced To Deliver Mediocre Returns (2022). Available at: https://seekingalpha.com/article/4562302chipotle-stock-priced-for-mediocre-returns (Accessed: January 3, 2023)
24 Borsa Earnings Call, Chipotle Mexican Grill Q3 2022 (Accessed: January 20, 2023)Earnings Call: continue to over index to younger people, pretty evenly split between male and female, we do have a little bit of a skew towards higher income (north of $75,000) (Time of reference: 47.10). Borsa Earnings Call, Chipotle Mexican Grill Q2 2022 (Accessed: January 10, 2023) Earnings Call: low-income consumer has definitely pulled back their purchasing frequency. Fortunately for Chipotle the majority of their customers are higher household income consumer (Time of reference: 28.10).
Note that higher income individuals are impacted far less by inflation due to their higher disposable income.
25 Dart, T. (2022b) Chipotle: Aggressive Pricing Could Backfire. Available at: https://seekingalpha.com/article/4560970-chipotle-aggressive-pricing-could-backfire (Accessed: January 3, 2023) :’In fact, we've already seen some shift to cost-savings measures among higher-income consumers, cited by Walmart, which sees $100K+ household income customers shopping with them more often’
26 .@MenthorQpro (2023) People are getting in debt like there is no tomorrow. Following the footsteps of our government ��. Available at: https://twitter.com/MenthorQpro/status/1616886268482277381 (Accessed: January 25, 2023)
27 Klein, D. (2021) Chipotle, Drive Thru, and the Path to 6,000 Restaurants. Available at: https://www.qsrmagazine.com/fast-casual/chipotle-drive-thru-and-path-6000-restaurants (Accessed: January 15, 2023)
28 Borsa Earnings Call, Chipotle Mexican Grill Q2 2020 (Accessed: January 10, 2023): digital business is roughly 50% of sales and a little under half is order ahead (Time of reference: 44.10); digital sales constituted 45.6% of revenue in 2021, compared to 46.2% of total revenue in 2020: Chipotle Mexican Grill (2021) FORM 10-K, https://ir.chipotle.com/sec-filings?cat=1 (page 5).
the added benefit of creating higher ticket transactions and more use by customers compared to in-diner tickets. Management has pushed their digital presence through multiple channels such as snapchat29 and digital products to incentives interaction: their most recent being Freepotle released on the 9th January 2023 which demonstrates gamified interaction. This also helps Steve Elis (CEO) fulfil his intention to make Chipotle more visible30. It is clear to me that all of this digital throughput helps maintain and grow brand awareness which is essential for maintaining Chipotle’s competitive advantage and driving high margin sales compared it its peers. The success of higher ticket sales has driven Chipotle to incentivise digital transactions even more. For instance, digital only products will continue as Gen Z and Millennials push for a digital/home experience over diner only31 .
It seems that Chipotle has also bucked the trend of the great resignation with ’85 -90% of restaurants staffed at model which is better than pre-pandemic levels. Pre-pandemic was in the 80% range32. This may well come from the increase of wages outpacing inflation and incentivising retention of staff33. Going forward staffing may become easier as the Federal Reserve increases interest rates resulting in more unemployment and making it easier for Chipotle to hire without increasing wages as dramatically34. Regardless of future or current staffing issues management are pushing ahead with automation to make the experience at Chipotle for guests and staff more convenient and efficient35. With initial inroads in to the automation of chipping and experimentation of AI at their Cultivate Centre it is clear automation is inevitable36. A further example of this includes the establishment of their Cultivate Next fund investing millions into Hyphen to automate the makeline with use of robotics37. If successful the drive towards automation through robotics and AI will allow chipotle to rely less on staffing and increase efficiency with a smaller restaurant crew.
Overall it would seem Chipotle has been able to leverage its brand strength and high income customers to offset the impact of inflation. Whilst upward pressure persists on certain food items38 inflation may well be coming down with CPI dropping from a peak of 9.1% in July
29 Kelso, A. (2023a) Chipotle promotes wellness with new bowls, augmented reality experience. Available at: https://www.nrn.com/fast-casual/chipotle-promotes-wellness-new-bowls-augmented-reality-experience? utm_source=social (Accessed: January 12, 2023)
30 Borsa Earnings Call, Chipotle Mexican Grill Q4 2020 (Accessed: January 9, 2023): New CEO has been trying to increase Chipotles visibility since 2018 (Time of reference: 46.00)
31Generational divide may reveal emerging restaurant trends (2022). Available at: https://restaurant.org/education-and-resources/resource-library/generational-divide-may-revealemerging-restaurant-trends/ (Accessed: January 7, 2023)
32 Borsa Earnings Call, Chipotle Mexican Grill Q1 2022 (Accessed: January 10, 2023) (Time of reference :29.50)
33 Wages increased 15% in 2021 compared to 2020: Chipotle 10-K 2021 (Accessed: January 20, 2023).
34 Borsa Earnings Call, Chipotle Mexican Grill Q3 2022 (Time of reference: 55.35)
35 Borsa Earnings Call, Chipotle Mexican Grill Q1 2022 (Time of reference 46.00)
36 Borsa Earnings Call, Chipotle Mexican Grill Q1 2022 (Time of reference: 33.30)
37 Jennings, L. (2022) Chipotle Mexican Grill makes first two investments through $50 million venture fund Available at: https://www.nrn.com/fast-casual/chipotle-mexican-grill-makes-first-two-investments-through50-million-venture-fund?utm_source=social (Accessed: January 18, 2023)
38 Borsa Earnings Call, Chipotle Mexican Grill Q3 2022 (Time of reference: 54.05) ‘still upward pressure on beef, oil and tortilla’
2022 to 6.5% in January 202339. Everything considered there is a real possibility that inflationary pressures have peaked and we will start to see disinflation. However, this could also be a blip in a vicious uptrend with supply chain constraints continuing to fall behind demand. The use of current data suggests Chipotle will be okay regardless with its pricing power and brand strength – although it is clear to all that disinflation or deflation may well be preferred. Whilst price increases could be starting to have an adverse impact on demand, we need to see more data going forwards to back this possibility. Staffing has had no real impact on the company with staffing improvements being made with its very competitive wage increases outpacing CPI prints, and it is clear that management are doing a fantastic job at pivoting the company digitally in the post pandemic age with inroads into robotic and AI to prevent future upsets caused by the great resignation. The impacts of the great resignation, supply chain upsets and inflation have been navigated very well by management and is testament to their ability. It is clear that the price of Chipotle Stock reflects this but with a PE of over 40; I would consider this stock overvalued although its price is explainable by the company performance since March of 2020.
Disclaimer: I do not own any Chipotle stock, but do intend to buy it at a much lower price. With this in mind I consider myself bias in favour of Chipotle and may have a more subjective interpretation of Chipotle making this analysis less objective.
39 United States Consumer Price Index (CPI) YoY (no date). Available at: https://uk.investing.com/economiccalendar/cpi-733 (Accessed: January 25, 2023)