“Chipotle Mexican Grill (3.4% weight in the Fund): In our first quarter letter, we introduced our investment thesis on Chipotle. To review, few restaurant concepts – even highly successful ones – break out of their local or regional market. Once restaurants hit a certain “escape velocity” to break free of the natural gravity of their local or regional market and obtain national scale, it is difficult to unseat them. Consider that most of the fast-food restaurants that lined Main Street America in the 1980s – McDonalds, Burger King, KFC – are still there today.
One thing we find remarkable about Chipotle is that it achieved national scale with fresh, responsibly sourced food. There are no freezers, microwaves, or can openers at Chipotle restaurants. The Humane Society of The United States awarded Chipotle an “A+” score on its Food Industry Scorecard, which measures animal welfare. It is hard to see how another fresh food focused, quick-serve restaurant might be able to match this scale – over 2,600 restaurants today – within a decade or more and with the same level of quality as Chipotle.
First, handling fresh food is not easy. Chipotle learned this lesson the hard way when they struggled with foodborne illness issues in some Chipotle restaurants in 2015 and 2016. Many restaurants would have been forced to shut down as a result of these mistakes, but Chipotle learned and improved their processes, and emerged stronger on the other side. Second, developing relationships with local meat and produce farmers takes time and farmers have limits on their supply. Chipotle is now a large and reliable enough buyer of fresh meat and produce that a small farmer would be crazy to cancel a Chipotle supply deal in favor of an upstart competitor. Finally, whether you order your regular burrito bowl at your local Chipotle, the one in Missoula, Montana, or Morgantown, West Virginia, you expect it to taste the same. Making freshly prepared food nationally consistent is a massive obstacle and requires top-notch employee training and, more importantly, high rates of employee retention.
To this last point, Chipotle’s CFO Jack Hartung recently noted at an investor conference that the biggest constraint to restaurant location growth, which they expect to accelerate in the coming years, is as much about staffing as it is real estate. Front-line restaurant worker turnover is notoriously high, averaging about 130%-150% per year across the industry, which makes consistency and quality harder to deliver. In response, Chipotle has stepped up its employee pay and benefits packages for front-line workers and especially its restaurant general managers who run day-to-day local operations. At a time when many restaurants are unfortunately struggling to stay open, Chipotle has the financial resources to make it a more attractive place to work for food service workers.
In recent months, we’ve TAKEN A CLOSER LOOK at how much stakeholder value our companies create. We believe companies that treat their stakeholders – customers, suppliers, employees, etc. – fairly will produce more sustainable shareholder value over time, all else equal. On the stakeholder value front, Chipotle is a shining star. We have recently seen more companies make reference to stakeholders in annual reports and press releases, but Chipotle has long been a mission-driven business and sets the standard for measuring stakeholder value. Since 2016, Chipotle has released a Sustainability Report in which it sets goals and measures its progress in categories like people, food & animals, and environment. In short, Chipotle “gets it.” By making sure all its stakeholders see value in their relationship with the company, Chipotle increases its opportunities to innovate and execute better than a competitor that might be more indifferent to one or more stakeholder.
We often hear skeptics saying, “Chipotle is just an overvalued burrito shop.” We do not believe this to be the case. You can’t compare what Chipotle does with a taqueria or burrito shop. Two-thirds of orders placed at Chipotle are bowls – something you don’t see offered at traditional taquerias. We’ve found it more helpful to think about Chipotle as freshly prepared, quickly served food with Central American flavoring. Not being constrained by any delivery medium like a burrito or taco allows Chipotle to be creative with their menu offerings. For example, Chipotle launched Lifestyle Bowls for customers who adhere to various nutritional disciplines, such as Keto, Paleo, Whole30, and high protein. The taqueria experience (which many people on the Ensemble team love!) is different from Chipotle’s and we do not believe the customer occasions (“I’m in the mood for…”) overlap much, if at all.
Finally, it is worth noting the success of Chipotle’s loyalty program, which has tripled in membership count over the past year to 15 million at the end of the second quarter. For some perspective, Starbucks’ best in class US loyalty program membership count is approximately 19 million. Not only does this speak to Chipotle’s relevance with its customers but it provides the company with better data analytics around customer order patterns. Chipotle plans to offer more granular data around the impact of its loyalty program to sales and order activity, but if Starbucks’ loyalty program provides an indication of what to expect, Chipotle loyalty members will visit its restaurants more frequently and spend more per order. The loyalty program connection also allows Chipotle to target offers to specific customers. For example, a customer who recently ordered for a group of four may be offered a free large order of guacamole and chips if they place another order for four. In other words, the loyalty connection can create a dining occasion that wouldn’t have otherwise happened.
So, while Chipotle may seem “expensive” on a near-term multiple of earnings, it has plenty of opportunities to grow into those expectations. In the US alone, Chipotle thinks it can more than double its current store count to over 6,000 locations. A longer-term opportunity is Europe and Asia where food with Central American flavorings is not as common as in the US. Chipotle has a few locations abroad but has not made a strong push there yet.
Few restaurants reside in our investible universe, but Chipotle checks off the three major categories: moat, management, and forecastability.”