Web Exclusive | May 2008 | By Fred Minnick

Chipotle Keeps Sizzling

Coming off a second quarter that had 11.6 percent comp increases, Chipotle announces new ways to become even better—and more profitable.

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After Chipotle announced last Tuesday quarterly earnings that beat Wall Street estimates by nearly doubling, analysts began wondering how the fast-casual concept can improve already outstanding profit margins.

The company reported second-quarter comparable-restaurant sales increases of 11.6 percent, revenue increases of 33.9 percent to $274.3 million, and net income increases 85.1 percent to $20.0 million.

During the investor’s call, Piper Jaffray analyst Nicole Miller asked if Chipotle was considering expanding its dayparts or drive-thru in an effort grow when margins are already so good. Steve Ells, founder, chairman, and chief executive officer, replied no and added Chipotle’s success comes from “keeping things focused” on making the food better and the operations more efficient. To that end, Chipotle has passed on offering breakfast, dessert, and other new menu items based on “our conclusion that we would be better served improving our present format,” Ells said.

“Because of efficiencies elsewhere on a P & L, we’re able to invest more in our food, buying increasingly high-quality ingredients,” Ells said in the call. “We’re also improving how we prepare our food, designing more efficient equipment, and optimizing elements of our restaurant design that help our managers and crews deliver a better food and better customer experience.”

It’s this focus and dedication to the brand’s “Food With Integrity” that leads Robert Baird analyst David Tarantino to believe Chipotle is leading the transformation to a new standard of quality for quick-service restaurant meals, much like Starbucks changed the way many people drink coffee and Home Depot revolutionized the home improvement retail segment.

“We expect the appeal of Chipotle to widen as the company develops more locations and begins to fully leverage the Food With Integrity concept,” Tarantino wrote in a forecast. “We think [Chipotle’s] highly popular concept has characteristics that are similar to many great consumer brands.”

Chipotle has produced double-digit comps in each of the last nine years, and Tarantino expects same-store growth to remain healthy (mid-single-digits or higher) but to moderate from extraordinary levels.

“We see long-term potential for at least 3,000 locations (640 after Q2-07),” Tarantino wrote after the second-quarter results. “A good concept, solid industry dynamics, and limited penetration should support robust unit growth (estimating +17–20percent/year) for the foreseeable future.” 

Chipotle plans to increase the number of company-operated locations by 21–22 percent or 110 to 120 restaurants in 2007, including franchise acquisitions. It acquired four franchise restaurants during the first quarter and four in early second quarter, eliminating the franchise operations that began under McDonald’s ownership.

Changes to Be Made

Chipotle’s executives love the current growth, but they’re still tweaking a few things here and there.

Ells says the brand is implementing a much-improved tortilla press, which will allow crews to not only serve hotter, more evenly heated tortillas but also do so more quickly and with less effort. In addition, the company is completing designs for a new grill, “which will allow our crews to grill our meats in a way that tastes much better, is more consistent and which is also easier for our crews to clean at the end of the day,” Ells says.

Chipotle is redesigning its second make line to function to fill orders more quickly and is attempting to improve design and functionality of building, says Ells, “so that they are more cost effective and at the same time improving their appearance, durability, comfort, functionality, and of course aesthetics.”

The Fresh-Mexican concept is also on track to be serving 100-percent naturally raised meats. Pork served at Chipotle is already 100-percent naturally raised, while 73 percent of chicken and 46 percent of beef meets that standard. In addition, 100 percent of Chipotle’s sour cream, and soon to be cheese, is now sourced from cows that have not received the synthetic growth hormone RBGH.

“Our customers are still not asking for [RBGH-free dairy], but we’re doing it because we know it’s better,” Ells says.

Monty Moran, president chief operating officer, says the company’s development of store managers has been the key to strong comps and profits.

“Our formula for success is based on these four fundamental principles: Identifying talent, developing managers, ensuring high standards, and removing obstacles,” Moran says. “[Our] managers are more energized and efficient in everything they do. … This enthusiasm can be felt across the counter and improves the customer experience.”

Moran says he and Ells has spent a lot of time in the field working with managers. The result has been a 30 percent turnover rate compared to 34 percent last year.

“This focus on developing managers from within is truly becoming part of our company’s culture and not just an initiative,” he says. 

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