Buying a Business: Chipotle Mexican Grill

Executive Summary

Chipotle Mexican Grill, one of the leading Fresh-Food/Fast Food Chain presents a unique combination of fresh food and fast food in the form of fresh tacos and burritos. The stores of Chipotle are always full of excited customers. The analysis of the company financial reports showed its strong financial position. One problem that it certainly faces is that it has not yet found any solution to securing its IT Data breach from POS solution which had resulted in past in a data breach. Other than this, the company has started to race upward with analysts forecasting its EPS to double by next year. By solving the problem of Data security by using secured POS solutions, patched software, and a vigilant data security team, the company can be considered for purchase.

Description of Company:

Chipotle Mexican Grill which operates as a Delaware Corporation along with its subsidiaries serves a very specific menu based on tacos, burritos, burrito bowls, salads and etc. which are made from fresh ingredients. The company operates around 2,363 restaurants throughout the US and has 37 international restaurants. The company mission is to change the way people perceive and eat fast food. The key vision and values of Chipotle revolve around the providing of food with valued integrity and focuses on changing the way people think and eat fast food. The company is committed to providing fresh ingredients with the use of sharp skills. The ultimate commitment of the company with the use of fresh ingredients is depicted in its slogan “Whole or Nothing”. The company cares about the ingredients that it uses and about the fact that where it comes from. They go beyond the line in order to emphasize quality and responsibility. The company keeps the environmental impact of its activities always in its mind (Chipotle Mexican Grill, 2018).

Current Financial Condition:

The revenue of the company increased in 2017 as compared to 2016 by 14.7%. This is notable as the revenue declined in 2016 as compared to the 2015 revenue by 13.3%. The average restaurant sales have increased by 3.9% in 2017 as compared to 2016 turning from a negative 22.9% in 2016 as compared to 2015. The number of restaurants increased in 2017 by 7%; as compared to the incline of 11.9% in 2016. The main factors contributing to this increment were the sales from new restaurants and comparable restaurants sales. Basically, other than this, the increment in revenue was also due to the increment in the average check by 1.2% which was due to the increment in the menu prices.

The operating and non-operating costs of the company also increased this year primarily because of the opening of the new restaurants. The general and administrative expenses increased by 7.3%, depreciation by 11.6%, other operating costs by 1.5%, occupancy costs by 11.4%, labor costs by 9.1%, and food, beverage, and packaging costs by 12.4%. The reason of the increment were higher avocado rates, wage inflation, and from the recording of the liability of $30 million of potential losses which were linked with the payment cards data security incident, higher bonus costs, and non-cash stock compensations (Chipotle Mexican Grill, 2017).

The current assets of the company increased in 2017 from 25% of the total assets to 30% with most increment noted in the cash. The current liabilities also increased from 13% of the total liabilities portion to 15% with major increment noticed in all three current liabilities accounts i.e. accounts payable, accrued payroll, and accrued liabilities. The company invested in equity increased from 61% to 66% of the total assets. Total liabilities accounted for 33% of the total assets.

The Cash Flow of the company shows an increment of $96689 thousand in 2017 majorly increased from the operating activities of sales revenue, depreciation, stock-based compensation expense, and loss on disposal of assets.

IT Infrastructure:

The company uses the internal network for the payment processing of their restaurants. The Point-of-sales software and hardware are used for the processing of the payments. With the need for Chipotle to have a POS system which relied on speed as well as reliability, the company has started to use the Aloha Quick Service POS Solution (Aloha Enterprise, 2016). Other than this, the company has considered using an internally developed software system and the linked hardware which was reportedly written off as impairment losses after discontinued use. The data security breach incident also shows the risk of using POS systems and having an ineffective data security team for the security and protection of the stakeholder’s data like the data of credit card of customers.

The incident was traced when malware was detected in the system of Chipotle which was tracking the information of the customer credit cards. It is not the first time such an incident has happened in this industry. Even then the retailers have not taken enough steps to protect their systems from malware. Just because any malware gets into a system does not mean it can get the data out as well. Chipotle can use data-loss-prevention platforms for reducing the data loss risks. Watching over the administrative credentials and the activity for any potential malware activity is good enough protection against cyber-crimes. Using patched software is another way of limiting the risk (Kerner, 2017). The IT team of the Chipotle is responsible for providing Desktop Support, and Restaurant Support and for the support to the Infrastructure Service teams which consists of technicians, contractors and Field specialists (Aguilar, 2016).

Investment Opportunities:

The company Chipotle Mexican Grill has been going upward from the start of the financial year 2018. The new CEO claimed that they can easily see the company double the business to around $10 billion in revenue (Duprey, 2018). The analysts, however, termed this claim as lacking any specifics and pointed towards the lack of fine-tuned financial objectives. Before the incident of food-borne illness in 2016, the company has shown double revenue streams each year. However, the competition since then has intensified. The company is now intent on closing its underperforming stores. However, whatever the reason behind this claim, one thing is for sure that Chipotle needs to expand to grow its business revenue. For this, not only it needs to invest in its underperforming stores, but also in acquiring any potential business. Chipotle can work on collaborating with an Indian company to enter the emerging market of India. The tacos and burritos also tend to have a place in the Indian cuisine. Another investment opportunity can be to invest in the underperforming stores to make them efficient and yield more revenue. Lastly, Chipotle can also look for opportunity in the Malaysian and Indonesian market for starting a joint venture with any similar operating domestic company.

Goals:

Looking at the growth rate of the company, it can be said that a target of increasing the EPS to $12 from the current $6 would be a better and more practical goal. It can be achieved by investing in the underperforming stores. Employees of these stores can be trained better, and the supply of fresh ingredients to these stores can be made better to overcome any problems in their underperformance (Nasdaq, 2018).

Another financial goal would be to increase the number of stores by 5% in 2018 to retain the expansion strategy. This has yielded better results for the company in terms of revenue in the past.

Lastly, the company should work on investing in IT infrastructure in order to better prepare itself against malware and cyber-crimes. This would not only strengthen our IT system but also would make sure that no such incidents happen in the future as well.

Financing Options:

Looking at the financing strategy of Chipotle Mexican Grill, it is evident that the company is dependent more on its equity funds as compared to the debt financing. This is a better measure and strategy showing its liquidity, and financial strength. This also shows the availability of financing for debt. The company has not been involved in any major financing activities in the year 2017 as well. As of December 2017, Chipotle has invested in Us treasury notes with maturities of less than or equal to one year. Other than this, it has also invested in a Rabbi fund for deferred compensation funds. For 2018 liquidity and capital requirements, the company has enough operating cash flow, cash reserves, and short-term investments to fund its required activities. For major capital expenditure of construction of new restaurants and investments in existing restaurants, the company has reported having enough financing available. However, if needed, it has the option of raising it from any financial institution in the form of term loan or any other suitable type of debt financing.

Annual Budget:

For the Annual Budget, It is expected that the cash reserves, operating cash flow, retained earnings, and short-term investments would be enough to finance the operationsof the company. For the contractual obligations and annual capital expenditures the requirement is.

Leases (Schedule of Future Minimum Lease Payments Under Operating Leases) (Details) $ in Thousands  Dec. 31, 2017USD ($)
2,018  $                 281,461.00
2,019  $                 285,264.00
2,020  $                 283,934.00
2,021  $                 279,816.00
2,022  $                 278,615.00
Thereafter  $             2,497,163.00
Total minimum lease payments  $             3,906,253.00

(Chipotle Mexican Grill, 2017)

  2018-2019
Leases  $                 285,264.00
Purchase Obligations  $                 161,953.00
Deemed Landlord Financing  $                         427.50
Total Contractual Obligations  $                 447,644.50
Total Expected Capital Expenditure  $                   30,000.00
Total Required  $                 477,644.50

(Chipotle Mexican Grill, 2017)

This does not include anything other than the planned capital expenditure and contractual obligations amount.

Reflection:

As per the financial analysis conducted above, there are certain things which are important to consider regarding this business. Firstly, Chipotle Mexican Grill is one of the leading fast-food chains in the US and has the potential to go a long way. Its growth has just started, and its success is expected to be larger than what it is now. Secondly, the company now run by the former Taco Bell Executive has very strong values and the unique ambiance of its restaurants which gives it the competitive edge in this time of aggressive competition where uniqueness is impossible to provide. Thirdly, all the financial data provides evidence for its potential to expand beyond borders in the international arena. Even with all the business-deadly incidents like the Data security breach incident, and the E-coli food-borne disease, Chipotle has not only survived the industry environment but also has lived up to the customer’s expectations. This shows that Chipotle should be considered for buying as it holds great potential for growth in the future.

Conclusion:

The analysis shows that Chipotle Mexican Grill can be considered for buying as it has the potential of growing strength in the coming years. By keeping the same pace of expansion and making plans for investing in its nonperforming stores and entering in the emerging markets, Chipotle can make a mark in the fast-food industry with its unique culture and service. To conclude, it would be a great opportunity to buy Chipotle at this time.

References:

Aguilar, N. (2016). Nelson Aguilar. Retrieved August 18, 2018, from Linked In https://www.linkedin.com/in/nelson-aguilar-80749b9

Aloha Enterprise. (2016). Hot concept Chipotle sizzles with cutting-edge Aloha enterprise POS technology. Retrieved August 18, 2018, from Retail Insights: https://www.retailitinsights.com/doc/hot-concept-chipotle-sizzles-with-cutting-edg-0001

Chipotle Mexican Grill. (2017). Chipotle Mexican Grill 10K Report 2017. Retrieved August 18, 2018, from Last10K.com: https://www.last10k.com/sec-filings/cmg

Chipotle Mexican Grill. (2018). Food With Integrity. Retrieved August 18, 2018, from Chipotle Mexican Grill: https://www.chipotle.com/food-with-integrity

Duprey, R. (2018, July 18). Can Chipotle Mexican Grill Really Become a $10 Billion Business? Retrieved August 18, 2018, from Fool.com: https://www.fool.com/investing/2018/07/18/can-chipotle-mexican-grill-really-become-a-10-bill.aspx

Kerner, s. M. (2017, May 30). Chipotle Breach Exposes Continued Point-of-Sale Cyber-Security Risks. Retrieved August 18, 2018, from eWeek: http://www.eweek.com/security/chipotle-breach-exposes-continued-point-of-sale-cyber-security-risks

Nasdaq. (2018, August 18). Yearly Earnings Forecasts. Retrieved August 18, 2018, from Nasdaq: https://www.nasdaq.com/symbol/cmg/earnings-forecast 

Appendix:

Balance Sheet:

Consolidated Balance Sheet – USD ($) $ in Thousands Dec. 31, 2017
Current assets:  
Cash and cash equivalents  $ 184,569
Accounts receivable, net of allowance for doubtful accounts of $0 and $259 as of December 31, 2017, and December 31, 2016, respectively 40,453
Inventory 19,860
Prepaid expenses and other current assets 50,918
Income tax receivable 9,353
Investments 324,382
Total current assets 629,535
Leasehold improvements, property and equipment, net 1,338,366
Long term investments 0
Other assets 55,852
Goodwill 21,939
Total assets 2,045,692
Current liabilities:  
Accounts payable 82,028
Accrued payroll and benefits 82,541
Accrued liabilities 159,324
Total current liabilities 323,893
Deferred rent 316,498
Deferred income tax liability 814
Other liabilities 40,042
Total liabilities 681,247
Shareholders’ equity:  
Preferred stock, $0.01 par value, 600,000 shares authorized, no shares issued as of December 31, 2017 and December 31, 2016, respectively 0
Common stock $0.01 par value, 230,000 shares authorized, and 35,852 and 35,833 shares issued as of December 31, 2017, and December 31, 2016, respectively 359
Additional paid-in capital 1,305,090
Treasury stock, at cost, 7,826 and 7,019 common shares on December 31, 2017, and December 31, 2016, respectively (2,334,409)
Accumulated other comprehensive income (loss) (3,659)
Retained earnings 2,397,064
Total shareholders’ equity 1,364,445
Total liabilities and shareholders’ equity  $ 2,045,692

Current Income Statement

Consolidated Statement of Income – USD ($) shares in Thousands, $ in Thousands 12 Months Ended
Dec. 31, 2017 Dec. 31, 2016 Dec. 31, 2015
Consolidated Statement of Income [Abstract]      
Revenue  $ 4,476,412  $ 3,904,384  $ 4,501,223
Restaurant operating costs (exclusive of depreciation and amortization shown separately below):      
Food, beverage and packaging 1,535,428 1,365,580 1,503,835
Labor 1,205,992 1,105,001 1,045,726
Occupancy 327,132 293,636 262,412
Other operating costs 651,644 641,953 514,963
General and administrative expenses 296,388 276,240 250,214
Depreciation and amortization 163,348 146,368 130,368
Pre-opening costs 12,341 17,162 16,922
Loss on disposal and impairment of assets 13,345 23,877 13,194
Total operating expenses 4,205,618 3,869,817 3,737,634
Income from operations 270,794 34,567 763,589
Interest and other income, net 4,949 4,172 6,278
Income before income taxes 275,743 38,739 769,867
Provision for income taxes (99,490) (15,801) (294,265)
Net income  $ 176,253  $ 22,938  $ 475,602
Earnings per share:      
Basic  $ 6.19  $ 0.78  $ 15.30
Diluted  $ 6.17  $ 0.77  $ 15.10
Weighted average common shares outstanding:      
Basic 28,491 29,265 31,092
Diluted 28,561 29,770 31,494

Estimated Cash Flow

Consolidated Statement of Cash Flows – USD ($) $ in Thousands 12 Months Ended
Dec. 31, 2017 Dec. 31, 2016 Dec. 31, 2015
Operating activities      
Net income  $ 176,253  $ 22,938  $ 475,602
Adjustments to reconcile net income to net cash provided by operating activities:      
Depreciation and amortization 163,348 146,368 130,368
Deferred income tax (benefit) provision (18,026) (14,207) 11,666
Loss on disposal and impairment of assets 13,345 23,877 13,194
Bad debt allowance 214 (262) (23)
Stock-based compensation expense 65,255 64,166 57,911
Excess tax benefit on stock-based compensation 0 (1,320) (74,442)
Other (218) (604) 582
Changes in operating assets and liabilities:      
Accounts receivable (140) (1,923) (3,504)
Inventory (5,250) (91) 262
Prepaid expenses and other current assets (6,710) (4,259) (5,259)
Other assets (2,587) (4,855) (5,619)
Accounts payable 10,908 (6,734) 19,525
Accrued liabilities 38,574 33,491 (7,440)
Income tax payable/receivable (4,173) 54,340 32,756
Deferred Rent 29,996 37,030 32,911
Other long-term liabilities 6,316 1,287 4,826
Net cash provided by operating activities 467,105 349,242 683,316
Investing activities      
Purchases of leasehold improvements, property and equipment (216,777) (258,842) (257,418)
Purchases of investments (199,801) 0 (559,372)
Maturities of investments 330,000 45,000 352,650
Proceeds from sale of investments 0 540,648 0
Net cash provided by (used in) investing activities (86,578) 326,806 (464,140)
Financing activities      
Acquisition of treasury stock (285,920) (837,655) (460,675)
Excess tax benefit on stock-based compensation 0 1,320 74,442
Stock plan transactions and other financing activities 26 52 (207)
Net cash used in financing activities (285,894) (836,283) (386,440)
Effect of exchange rate changes on cash and cash equivalents 2,056 110 (4,196)
Net change in cash and cash equivalents 96,689 (160,125) (171,460)
Cash and cash equivalents at beginning of year 87,880 248,005 419,465
Cash and cash equivalents at end of year 184,569 87,880 248,005

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