Rule #1 Finance Blog

With Investor Phil Town


Here's Part 2 of Lee's Chipotle (CMG) Homework.  My comments are at the end.

Hi Phil Town,

(I apologize up front for the length of this — edit at will.)

First, here are a couple of recent articles on Chipotle:

1.  Investor's Business Daily recently wrote a piece (6/30/06).

Points of interest from this article:

  • Profit grew 199% from 2004 to 2006
  • McDonald's now owns less that 60% and will be fully divested by year end (I wonder if this selling has kept downward pressure on the stock).

2.  Ryan Detrick of Schaeffers Research posted his assessment of the IBD article (dated 7/5/06). His is a "contrarian" sentiment, where bad news is good:

"what I really like is [that] the analysts continue to doubt the shares
– there is only one buy out of eight total recommendations. This could
lead to an influx of upgrades as the shares continue to outperform"

James wrote a blog follow up here on your site:

"aren't we supposed to be working with
companies that have ten years of data? Based on the book, Chipotle
isn't Rule #1". 

He's right, of course, and I expected you to "ding" me
for this. I touch on this some more below.

Ok, on to your question:  Panera is competing in the fast healthy food
marketplace with Chipotle, and Sonic is reinventing burger/drive-in
restaurants from its base in Oklahoma. Which one gets our vote?

So, being an engineer, I decided to take a "data driven" approach and
build some tables. This first compares some objective metrics of the
three businesses:


1. All three appear to have plenty of room to grow, even Sonic, who after 50 years, still has more states to conquer.

2. How can Chipotle generate more revenue than Sonic, with less that 1/5 the number of locations?

3. Panera, and especially Chipotle, are younger, and have less
consistent financial performance. Chipotle has been doing great over
the last couple of years, but doesn't  have 10 years of solid results.

4. All of these stocks have dropped recently. The big chart shows money flowing out.

Here are some more subjective comparisons:


1. Chipotle is one of the only restaurant chains to grow organically
without franchising.  This is why their revenue is so high — rather
than 5 – 8%, they keep it
all.  While the other chains develop independent franchise business
owners, Chipotle develops employee store managers. Obviously provides a
lot of control, along with risk and capital expense.

2. Chipotle marketing seems to be "funky", leading me to believe they
want the 16-24 single adults. Sonic wants the same market, but also
targets little kids. Panera says professional and suburban mom, among
others, to me.

3. Sonic is smart to target kids (like McDonald's does), but I worry that any hamburger+ business can't maintain its moat.


Here's how I see the choice:

1. Sonic is an older style Burger+ business with good (but not
spectacular) Rule #1 financials. It's a solid company, but it doesn't
resonate with me. Pass.

2. Panera and Chipotle represent something new, and have both the
inconsistent financial performance and super high recent growth rates
to go with it.

Panera is more mature, has more analysts recommendation's (7 to 1), and
seems closest to meeting the Rule #1 criteria. It's selling below the
MOS, so when Mr. Market turns, buy it.

3. Rule #1 says I shouldn't buy Chipotle at all, but if I do, limit it
to the 10% "risky biz" category. Wait for its track record to improve
so the big money investors can "discover it" and drive up the price.

Phil Town
: Is my Chipotle MOS price valid without 10 solid years of numbers?
You used 5 years in your analysis of Panera (Blog 7/21/05). How far can
you push it, and do you (or should you) factor this into the MOS?


– lee

My critique of Lee's homework:

Awesome job, Lee.  I think you brought sunlight to the shadows. You've
narrowed down the issue to whether we can go for Chipotle with less
than ten years of numbers and remarked that we can go for it in our Risky Biz portfolio.

Frankly, I like the heck out of it on all levels including the gut.
When I tell friends here in Jackson Hole about Chipotle they all want
one to come here.  The only places in town that serve Mexican are all sit-down restaurants.  Burritos are almost by definition fast food, so when you want a meal in a wrap it's nice to be able to get it quick.

Here's what I'm wondering.  Since they've been in business for 13
years, where is the old financial data?  I wonder if corporate would
cough it up for us.  Want to take a shot at that, Lee?  See if they have it there for investor scrutiny?  See if we can get a better sense
of the historical trajectory to get a better feeling for its

That said, these guys are clearly not breaking new ground in some
technology business.  Come on.  It's a burrito.  And they are not
creating a market.  The market obviously exists.  Burritos?  And, unlike Google, it's unlikely that something is going to come out of
nowhere and blast their moat.  It's a burrito.  Someone can copy them
but seems to me like they have the jump.

So let's understand the purpose of way back historical numbers: they
exist for us to predict the future. 
What they show us is how well the
CEO is controlling the growth of this business.  Is he all over the place or is he totally consistent?  Obviously the more consistent, the
more predictable.  A set of wonderfully consistent long and short term
Big Five numbers tells us a lot about what to expect for the future.

So, Lee, since you're leading this parade quite nicely, how about your
views on Chipotle with all of the above in mind.  Must we still
restrict it to our Risky Biz portfolio or can we stretch on this one and treat it like a well-proven biz?

Now go play!

Phil Town