Why International May Finally be a Focus at Chipotle
Assessing the change in narrative for Chipotle's international expansion
A few months ago I wrote an article titled “What is the next burrito?”. Like Starbucks and espresso, Chipotle popularised a nascent food trend and built a scalable brand around it; growing like a weed in the interim. Investors want to discover these brands before they become mainstream. I offered a few suggestions, but as far as Chipotle is concerned, I concluded that the next Chipotle might be… Chipotle. While Starbucks went on to become a global enterprise, Chipotle is still, for the most part, confined to its domestic market.
After reporting third-quarter earnings a few weeks ago, the business looks to be in good shape as it approaches a $10 billion revenue run rate and is on track to open a record number of stores in 2023. With ~3,300 stores in their portfolio, investors were pleased to hear that next year’s guidance for new store openings (285 to 315) indicates an acceleration compared to the current year. Chipotle is a resilient business. After the catastrophic impact of the 2015 E. coli scandal, the business evolved and bounced back. During the pandemic, the business embraced digital, doubled down on drive-thru Chipotlanes and permanently shifted the volume composition of its stores.
Today, roughly 60% of a store’s volume is generated via the front-line service team, compared to ~80% pre-pandemic. This shift plays in Chipotle’s favour because its margin-accretive and helps bolster throughput; a variable the management team are fixated on. To me, there’s a lot to like. It’s a tried and tested scalable formula with great unit economics that is decades away from saturation. This is evidenced by the company’s solid restaurant-level margins; which stand close to 27% in 2023, as well as the healthy trends in average restaurant sales. Most importantly, while Chipotle has increased pricing on occasion to offset inflation, growth is still being powered by transaction volume; implying customers are absorbing higher menu pricing relatively well.
Under the hood, gross, EBIT, and net margins are improving annually, the company has no outstanding debt, a healthy balance sheet with ample cash, operating efficiencies with negative cash conversion cycles, and is expected to deliver double-digit growth for the foreseeable future. While the company is hardly a share cannibal, the company has knocked out ~11% of the sharecount over the last decade. While the vast majority of that came between 2016 and 2018, the board approved an additional $300 million authorisation in Q3, following their $226 million repurchase during the same quarter.
Before the pandemic, the company was targeting ~5,500 stores across North America. Recently, they upped their target to at least 7,000 on the back of their efforts to lean into digital (which accounted for 37% of sales in Q3) and drive-thru. Both of these factors play into Chipotle’s strengths. Domestic focus is an obvious strategy for Chipotle. It is where their brand is strongest, where their supply chain is optimised, where their playbook is established, where the affluent customers are, and where the known demand is. But to become a global brand they have to… well… become global and venture overseas.
After launching their first couple of ex-US locations back in the early 2010s, most investors would be shocked to hear the company had only opened 61 international stores thirteen years later. It doesn’t surprise me its never been a focus. Chipotle’s outlay for marketing is typically in the low single-digit range as a percentage of revenue. To conquer continents like Europe or Asia, the company would likely have to endure decades of suboptimal cost structure as it builds out a supply chain network and awareness. Brian Niccol claims the top line component (demand, in other words) looks great in Europe today, but remarks they are still “working hard on how we get that to flow to the bottom line”. When comparing US and international expansion, for years the US has been the safest bet. Even today, management is claiming domestic store count can double before they even come close to their 7,000 target.
While domestic saturation is still a long way away, I have reason to believe that Chipotle are now in a strong position to expand internationally and that management may be telling investors this is the case.
Once every few years there is a wave of headlines that read something along the lines of “Chipotle is ready for global expansion”. Until now, when international activity finally looks like it’s about to be prioritised, those headlines have been misguided. It’s been an aspiration of the company as far back as 2008; when they opened their first non-US store in Toronto, Canada. Shortly after, they opened a few more stores, including some in London; their first venture into Europe. A lot of excitement was drummed up around the 2013 to 2018 era before Brian Niccol was appointed as CEO; when the expansion took a breather.
Read between the lines (the lines of the earnings call transcripts that is) and you’ll recognise that international development has long been a passing fancy. Not something management took too seriously and, to their credit, not something they got investors’ hopes up about.