Chipotle Mexican Grill, Inc. (CMG) Earnings Call Transcript & Summary

Good afternoon, everybody, and welcome to the session for Chipotle Mexican Grill. I'm David Tarantino, the restaurants analyst at Baird, and I'm pleased to introduce the management team from Chipotle here today. As you know, Chipotle is a leader in the fast casual segment. And has a brand that's established an unparalleled standard of quality. And the brand went through some difficult times in 2015, '16, but emerged from that with this new leadership team in a very strong fashion. So here to tell us more about the story today. I'm pleased to welcome CEO -- Chairman and CEO, Brian Niccol; CFO, Jack Hartung; and the Head of Investor Relations, Ashish Kohli. So welcome. Thanks for joining us.

Yes. Thanks for having us, David.

Great. Brian, I thought it would be a good place to start the session here by having you give a little overview of the state of the business at Chipotle, and your current strategic priorities. And then perhaps we can drill down into some more detailed questions on the outlook.

Sure. So first, obviously, as you think about all the unexpected events that have happened most recently and some of the tragic events that have happened recently. Yet we continue to stay focused first and foremost on keeping all our employees safe and supported in the appropriate fashion. And then obviously do our part to hopefully bring everybody on a positive footing and continue to build diverse culture where everybody truly believes they have equal opportunities for a bright future. So we're navigating that right now, and it'd be hard to get started talking about our company without addressing that first. But obviously, we really hope things get to more of a peaceful approach on moving forward, and we'll be a part of, I think, hopefully, the solution going forward. With that said, just in regards to Chipotle more specifically, we've kind of laid out our key strategies, which really were about making the brand more visible and loved, running great restaurants with being brilliant at, what I would call the restaurant basics, so great throughput, great teams, great culture, great food. And then obviously, our digital system, investing and making the Chipotle brand much more accessible through our digital transformation. And then creating a rewards program and call it, an analytical company that can mine for insights and really be on the front foot of communicating with our customers and employees, frankly. Happy to say all those strategies have really, I think, take huge steps forward. And you all probably saw on our most recent earnings release, we were off to a really brilliant start with January and February running mid-teens with high transaction growth. And frankly, a lot of our investments in digital operations were paying off in a big way. And that was kind of the big driver behind the performance. Obviously, the COVID pandemic hit, and we've really made sure that the company has a strong liquidity position. One of the things that's -- I guess now the new term is a fortress balance sheet. I -- Jack was ahead of his time. He already had the fortress in place. And so we had $900 million of cash on hand, no debt. We did secure an additional $600 million revolver just to really kind of make sure that we are rock-solid from a liquidity standpoint in the event there's a step backwards in the pandemic or whatever unforeseen issues might happen. The good news is as you think about the COVID pandemic, we've started to see our restaurants reopen in some states. And all the investments we've made in digital, really, I think, accelerated consumers' behavior in the adoption of our digital business. And you probably saw all this, a high point was probably 70% of our business was digital. Our rewards program, frankly, went from like $8 million or $9 million to close to $12 million plus. And the thing that I was optimistic about going forward was, I think, we'll hang on to those digital sales because I think they'll be sticky. And what we're seeing is as we reopen dining rooms, so those digital sales are proving to be sticky, while our dining rooms start to recover. So that's been a good positive, I guess, force behind the business as we continue to work to reopen restaurants. But the way I've kind of talked about it at -- with our team is really, this second quarter has all been about ensuring we've got liquidity, ensuring the business is on stable footing, investing in our people so that we can support them correctly through this pandemic, keep our restaurants running. And then kind of as we move into the reopening phase, it's all about reopening the dining rooms in a smart way, while hanging on to our digital business. And then hopefully, by the time we get to the end of the year, you can start to see things with consumers start to behave how they would access our dining rooms in a normal fashion, while we continue to drive our digital business. So that's how we're kind of thinking about our approach. The good news is the brand continues to be very strong. Our operations continue to perform very well, and our digital investments have paid huge dividends here in the near term, and I think they will longer term.

And just a follow-up to that. As you think about driving a recovery in the business, you've had a lot of success driving sales momentum since you joined the company. And I'm just curious to know if you think the same levers that drove that prior momentum will be the levers you need to drive the recovery in the business or whether there will be something new required or changes in the strategy required to get back to where you want to be on the sales line?

Yes. Look, you know what, David, I actually think the pandemic accelerated consumers' adoption of our digital system. So I actually think our strategies are the right strategies for the recovery. Because digital will continue to play a key role in building that top line, while we run the restaurants with excellence. Now the one thing that I will tell you that's probably an extension of our digital strategy is we truly now have a second digital kitchen business. And you're going to see us starting to support that digital kitchen, digital make online with innovation targeted directly to that new capability. Because now we've got enough scale on it, where we could move the needle by doing -- for instance, we've talked about this for a while, quesadillas, right? We may now choose to launch quesadillas only via our digital kitchen. And you'll see us continue to use our database, which I think today, it's at 12 million, 12.5 million, probably going to 20 million. You're going to see us lean into that even harder because now you've got the scale in it where it can be a meaningful contributor to the business. So I think this is more a function of we've accelerated our digital strategy. So as a result, we're going to be able to, I think, be more aggressive in executing against sales-driving initiatives with the digital kitchen and our, call it, customer database.

Interesting. I want to come back to some of that in a minute. But before we jump into questions on -- further questions on how you think this recovery curve might look, I wanted to ask. As you think about the long-term potential of the brand, has anything changed in your mind? I think you laid out some targets of over 5,000 units in the U.S. and $10 billion-plus in sales. As you go through this crisis, have you reset your expectations around the brand and its potential longer term?

If anything, I'm more optimistic on getting to those targets and exceeding those targets. Because if you think about just the individual restaurant, we now truly have a meaningful digital business to go with our -- in restaurant business. And if you remember, we were always talking about, can we get back to $2.5 million average unit volumes? And I think the answer is absolutely. And I think it's going to be one of those things where once we get there, we'll be talking about where we go from there. I don't believe it is the pinnacle, I think, it's going to be just part of our journey on growing Chipotle. And I've got even more confidence that we'll get to $2.5 million here in the near term and mid to longer term, we'll be going past $2.5 million, which gives me a lot of excitement. Because with those types of economics, we'll clearly -- it also presents us the opportunity to do even more new unit building. And now that we've got a digital business, we've got new formats that even makes sense, so that trade area is that before we used to say, not sure we could go into that. Now when Jack and I are looking at trade area maps, there's almost no site we can't figure out how to put a Chipotle in, whether it's a Chipotlane only, more of a digital-heavy concept, a full access Chipotle. We just have so many options now with our physical asset to give people the access to Chipotle. And then also fit the trade area. So look, I think 5,000 restaurants is another one of those targets were unlike we absolutely, I think, see a path there. And again, it'll be another one of those scenarios where I think as we start to get closer to it, we'll be talking about how we go past it. So I'm very optimistic about not only the top line and the new units, but the economics associated with all this growth. Our margins, I think, will continue to demonstrate that this is really one of the best restaurant models that you can find in the industry.

On that front, the historical has peak on unit economics was -- included restaurant margins close to 27%. So is I guess, a hot debate in the investment community on whether you can get back to those kind of levels. So I don't know if, Brian, do you want to answer that question or Jack. But what's your thoughts on getting back to that peak unit economic model over time? And what needs to happen to get there?

Go ahead, Jack.

Yes. David, what we've talked about is when we were at those peak margins, our volumes were $2.5 million, and the margins were 27%, 28%, we offset a bit as I said. When we get back to $2.5 million, we can deliver a margin in the mid-20s, so call it, 25%. And the only difference between the 27% or 28% and 25% is inflation. We did not keep up -- somewhat intentionally did not keep up with labor inflation. And the other piece is part of our sales right now are delivery, and so that takes a little chunk out as well. But we're still very confident that when we get to $2.5million, we can get to 25%. If we get to $2.7 million, that's where you'll see a 27% margin. We see that relationship kind of continuing one-for-one, every $100,000 layer of sales should add 100 basis points of margin. So we can get back up in that margin range, but it will take a little bit more sales. But listen, I'm totally in agreement with Brian that what we saw going even before COVID and now during COVID, just gives us all much more confidence that we'll get not just $2 million, but then beyond the $2.5 million.

Got it. Okay. That's helpful. And then maybe turning to a little bit more questions about this kind of near-term recovery pattern. And I know on the last call, you mentioned that you had a -- and seen same-store sales improve to the down high teens in the third week of April. And that was before a lot of your restaurants started potentially opening or before market started really opening their economy. So I was just wondering if you could maybe comment on what the shape of the recovery curve looks like as more markets open? And what your view is on when we might start seeing comps get back to the positive territory or if it's too soon to tell or not?

Yes. Look, obviously, we've seen clearly regional distribution and our ability to open dining rooms, which has probably been the biggest delta in seeing the sales recovery path. So I think we have 10% to 12% of our dining rooms open right now. And probably by the time we get to the end of June, we'll probably be over 50%, closing it on 60%, assuming everything continues to progress the way it has been progressing. We've taken a very cautious approach, David. Frankly, we've even kind of used our stage-gate process on how we'd reopened. We started with opening 1 restaurant, just north of Dallas, 1 restaurant just north of Atlanta. We did it for like a week, wanted to make sure the signage worked, we wanted to make sure our team members felt good. And the good news is we saw the right behaviors so that everybody felt confident to open the dining rooms. And then frankly, our team members were part of the group that helped open the other restaurants. It wasn't just us, saying, "Hey, okay, it's time to open." So we've been very, I think, effective in reopening the dining rooms. I'm glad to say we haven't had a bunch of start stops. It's been kind of just a slow role. And one thing that's definitely true is we're seeing consumers have a desire to come back to the dining room. And even if it's not necessarily to sit down and eat, they have a desire to come back into the restaurant, move down the line and come back. But what I'm happy to say, though, is we're seeing the digital business remained in that 80% to 90% of what we achieved before we open the dining. So our belief of digital being sticky is proving out, while we've got recovery occurring in the dining room. But we probably only recovered, in the restaurants that are open, 30%, 40% of the dining room to date, while we've been able to hang on to 80%, 90% of our digital sales. So versus when you look at some place like the Northeast, it's still 90% digital, right? So look, I think all the indicators are positive, and it's going to be kind of a progression on how we recover going forward. But our goal is to open in a fashion where we don't have to go backwards. So that's been our approach.

Got it. And maybe you're not willing to elaborate. But would that last comment on kind of recapturing that percentage of dine-in sales. Would that imply that comps in those units where you've opened those dining rooms have gotten back to positive since you've opened the dining rooms?

Look, they've definitely seen improvements from where we were because hanging on to those digital sales is a meaningful piece to the business. But it's really the performance varies from region to region. But indications are, Chipotle has the ability to regain its sales strength prior to this crisis. It's just going to be a process of how we reopen. But the early indicators on where we reopened is a positive outcome for us. And our strategies are working where we're running really good operations with really good teams with a really strong digital business. That is playing out the way we would hope it would play out.

Got it. And on the comment that the digital business is sticking. I think that's very interesting. Do you think it's a function of consumers wanting to access the brand that way more permanently? Or do you think that's a condition of the current crisis? And then maybe a second question would be around what are you doing with this database of kind of this rising database of consumers you have in that digital ecosystem, if you will? And are you really starting to pull the levers on driving transactions or frequency with that group of consumers?

Yes. So on your first question, what we've definitely seen is these digital occasions are different occasions for people. They are dinner occasions, they're weekend occasions, they're group occasions that before they weren't accessing the business with. And what we've seen is people start to return to their normal routine, whether that means going to work or just going out, we've pick up their dining room occasions. But what we have not seen is this trade off. It really appears that these are occasions. And so that was what our belief was going into this. The other thing that's been really interesting is that, and I think we talked about this before. It used to be our in-store customers were our in-store customers, our digital customers were our digital customers. And we only had probably like 4% overlap where people did both. And now what we're seeing is, obviously, a lot of these in-store customers have adopted the digital business. And that venn diagram has expanded where they're doing both. And in the markets where we reopen the dining rooms, we're seeing that behavior play out, where they're still ordering Monday night dinner for the family, but they're then showing up on Tuesday to go have lunch as an individual. So -- and I'll give you a for instance, when I was in just north of Atlanta, I was in the dining room, there happen to be 2 guys eating in the dining room at that time, one person was a UPS driver, the other person appeared to be some form of a construction worker. And I just asked the both gentlemen, I'm like, "Hey, I'm just curious, what do you think of how we reopen the dining room?" And the guy's reaction was, "Thank God, I'm so tired of eating in my car." So I do believe customers have a desire to have that dining room occasion to be part of their routine of occasions. And then the good news is now, Chipotle is top of mind for those off-premise occasions, for those group occasions that perhaps we weren't before. We've also gotten a lot of feedback from our in-store customers. I don't know if you saw the most recently, we did this customization push on the app, where people were just shocked that they could order in the app and get their salsa on the side. Or they could get extra this or half black beans, half pinto beans and light. So we just opened the customization suite for these people a little bit more, and they're like, "wow, this is amazing". And then the convenience aspect of it has proven to be really valuable. So that's how we're seeing it play out. To your question on how are we using all the data? Again, this has been a real accelerant for us. We -- I think we talked about how we had cohorts, and we've been experimenting with these cohorts. We've now turned that into ongoing, what we call, journeys. And so for light, medium, heavy users, based on your performance, we've created what we would call an ongoing journey. So we understand how you like to access Chipotle, and we have a journey that's for better terms, always on with you. Okay. And with each of these frequency groups, we have these always on journeys running. Then we've also got the supplemental journeys where we're like, "Huh, you know what, you came in for a group occasion on Monday, but we haven't seen you back for that group occasion". We've seen you do your traditional journey. And then we're supplementing those journeys with what I would call the occasions where we think we can bring you back and keep you engaged. And that is proving to be really effective because we're seeing frequency gains in every one of those cohorts of light, medium, heavy users. And I think we talked about this, one thing that's been a real kind of advantage is as we built this database, we've had a lot of light and medium users. So there's frequency opportunities, a plenty.

Yes. Great. Just a quick one on delivery. I mean, how much of the, I guess, recovery curve has been just getting people into that delivery channel of yours? And I guess maybe a side related question to Jack, is, what are the margin implications of having a higher mix on delivery? And is there a way to sort of price that channel in a way that makes you more margin neutral to the rest of your business?

Yes, well. David, those were all good answers in your question. The -- look, the reality is our entire digital business grew dramatically. So our order-ahead business, like just to remind everybody, the best transaction in the Chipotle business is a digital order-ahead business, where people come in and pick up or pick up via Chipotle. That has got our best economics, our best margin. So we're working from there when you talk about a delivery transaction. You're not working from our in-store transaction. We're working from our digital transaction, okay? But the thing I'd like to remind everybody is our delivery business grew about 150%, our order-ahead business grew 120%. So both grew dramatically. And what we've been experimenting with, frankly, is delivery on how do we price accordingly so that it can be something we want to continue to have as a business when it's no longer growing at 100-plus percent, and there are a lot of levers from a pricing standpoint. And the good news is what we've learned. Just like our base menu, there is pricing power there. We're realizing we have pricing power and a great value proposition in that delivery channel as well. So I'm pretty optimistic that we're going to continue to grow the order-ahead business, especially as we build more Chipotlanes. And especially as we market much more aggressively about the order ahead. Recall, we haven't really marketed the order ahead occasion until we just did this customization app focus. Because when COVID hit, we hit the pedal on delivery, and we're seeing a nice response to our order-ahead business right now, too. So I think there's growth to be had in a meaningful way in our order-ahead business, and delivery will come along for the ride because that's an occasion that I absolutely believe Chipotle has a right to win. Our food delivers well, we're fast and we're a great value proposition. And one of the things that we've learned during COVID is families love accessing Chipotle because everybody gets exactly what they want. Instead, I don't know about you, but in our household is like, "who do we want to order in?" Next thing I know I'm ordering from 5 different places. And one thing we can all agree on, now maybe this is a little bit of a bias is Chipotle. So all 5 of us can order from Chipotle together, but I think that's also a function of what's going on here. Jack, I don't know if you want to add anything specific to David's questions on the margins.

No, listen, you said it perfectly, Brian, I would just to recap it, say that we believe that we have levers that we can pull. So that even if we get back to the exact same volume and more of it is delivery, and that would have the potential to dilute our margins. We have ways to pull the levers because of the value that Brian described, because of the efficiency we have with the digital make line to recapture that margin.

Right. So in the long term, I think, Jack, you've been saying our economic model remains intact, where if we did that high, you got 25% margins. Some have called us conservative on that, but...

Fully intact.

We're making sure we keep intact.

Yes. And then the Chipotlane, to the point you alluded to is it's early stages. We're still under 100 and Chipotlanes and the more we build, the more confident we are that this is the way that people want to -- a lot of people do want to experience the brand. And with COVID and what's happened to the real estate market, we think this is going to give us a greater opportunity, both with new stores and potentially with remodels and relocations to get even more Chipotlanes. So you'll see a number of different efforts over the next few years for us to bring more Chipotlanes to more markets.

Yes, Jack, thanks for preempting my next question, which was about you…

We already answered it.

Yes. But my thought is you are in control of your development outlook. You don't have to convince franchisees to grow. And you have plenty of capital, and you have a great format with this Chipotlanes. So I guess one question on everyone's mind is, can you accelerate coming out of the crisis and grow even faster than you have been given those dynamics?

Yes. Listen, I think the answer -- the short answer, David, is yes. We've already seen that we have access to more sites. We're seeing others are shying away from sites. They're pausing, let's call it a pause for now. And that gives us an opportunity to go after these better sites. Now we'll stage how quickly we open them because the thing we won't do is because we happen to have greater access to sites. We're not going to over -- we're not going to outgrow our human capital, okay? Now the good news with that is our turnover has dropped dramatically. And so these 2 things are happening at the same time. So I think we will be able to accelerate the openings, but just rest assured, I would rather sign up the deals. Put it this way, we're not going to walk away from deals because we don't have the people ready to step into them. We will get the deals and then we'll stage those deals for when we have people that are trained and ready to move into those new sites. So I think the net-net of it, we definitely will accelerate in terms of how fast and how many are going to open exactly in 2021, too early to tell, but we're optimistic about where we go from here.

Great. And I think we have about a minute left. So I wanted to ask, Brian, just kind of a big picture question. We've probably already addressed this in some ways. But I guess what are you doing right now to make the company better coming out of the crisis versus maybe what -- where you were heading into the crisis? Like what is the 1 or 2 key things you think will make Chipotle a better company as a result of what you're doing now?

Yes. Look, I think the investment in our people and our culture is going to be invaluable going forward. I've said this numerous times, when you get into a crisis is when you finally really see the how strong of a leadership team do you have, do you have the right leaders, not just at the executive team level, but throughout the organization. And will people make decisions consistent with the culture that we are trying to create? And that's going to be invaluable going forward, David, and the way we're seeing it show up right now is just in team turnover. The stability in our teams and I got to tell you, when I've flown out to visit, I've gone to numerous states to visit our restaurants. And our teams are more energized, more passionate, unbelievably grateful to be a part of Chipotle and moving our purpose forward around food with integrity and cultivating a better world. I just think our ability to invest in our people and our culture is going to be one of those things that we've walked the talk on, and it's going to be one of those things that differentiates us going forward. There's obviously the business aspect, too, where -- and I touched on this. I think being able now to take advantage of a scale digital business as a part of Chipotle versus building to scale is one of the things that we're investing aggressively with here, too. How do we make sure we got the right organizational capability to drive from where we are? I don't want to go backwards on the gains, I want to build from these gains. And that's going to be another key piece of the puzzle for us. And one of the things I'm really excited about is we're not having a problem attracting more digital talent. People want to be a part of, I guess, the Chipotle digital kitchen proposition as much as they want to be a part of Chipotle, the original experience. So those are the 2 biggies. So like how do we build from here on digital, and how do we really, I think, garner the power of our culture and our people.

Great summary. Thank you, Brian, Jack and Ashish for being with us today. I really appreciate your time. And for those on the line, the next sessions will include Bright Horizons, Five9, Quanta and Watsco. Thanks a lot, and have a good day, everyone.

All right. See you later. Thanks David.

Thanks, David.