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

All right. Good morning, everyone. I'm Brian Vaccaro, the restaurant analyst here at Raymond James. And we're very excited to have the team from Chipotle join us to wrap up day 3 of our North American equities conference. Before diving in, just a quick comment on the format. It's going to be a fireside chat. If you have any questions, we'll do our best to work them in. But please feel free to submit them over the OpenExchange platform, which will come directly to my email. So with that out of the way, I want to welcome the Chipotle team, including CEO, Brian Niccol; CFO, Jack Hartung; and Global Head of IR, Ashish Kohli. Gentlemen, thanks for joining us today.

Thanks for having us.

So we've got a lot to cover today, but maybe just to start at a higher level. It's certainly been encouraging to see comps for you return to solidly positive territory in July. It seems that the industry trends -- broader industry trends have gradually improved since then. And the gale-force winds of COVID, they've been a significant headwind for most in the industry, but several components of your business and strategy have provided a competitive tailwind and really seem to accelerate that digital flywheel. So maybe start by touching on just what some of your most critical advantages have been in your view? And maybe just highlight a few of the more significant tactical wins scored by your teams during COVID in these areas.

Yes, sure. Thanks, Brian. Yes. Look, fortunately, Chipotle, prior to COVID, was, I think, investing heavily in the food safety and well-being aspect of our business as well as into our digital business. And those 2 things, combined with our commitment, Food with Integrity, and really the brand's purpose of cultivating a better world, I think just set us up to be able to navigate those really challenging COVID headwinds. And obviously, the pivot we made to digital and having that digital system in place, from the digital kitchen to the digital access points for the customer, meaning the pickup shelves as well as delivery and then the rewards program just became a real accelerator to get people access to Chipotle when we weren't allowed to have our dining rooms open and people were staying at home and no longer going to work. And then on the food safety and wellness aspect, back in January, before even really the COVID -- it was January or February, I was talking to Kerry Bridges, she's our Head of Food Safety and Wellness, just asking her, "Hey, our practices, how does that stack up against in the event COVID shows up in the U.S. in a big way?" And I was delighted to learn that the investments we made in air filtration, the investments we've already made in enhanced sanitizers in front of house, back of house, the hand-washing protocols, the focus prep, all the things that we were doing -- paid sick leave, nobody works if they're not feeling well. So we already had a lot of the things in place. Frankly, the only 2 things we had to implement new was the idea of social distancing and wearing masks. So our operators were very capable of executing within this COVID environment, and we made the enhancements that we had to make. And then fortunately, our -- we've got great people in our restaurants and above our restaurant, leadership team, that took all the changing dynamics of what you were permitted to do, frankly, in every county or every municipality. And I think that's a testament to the communication of our organization. We do a great job, I think, of communicating in both directions, meaning our general managers back to the corporate office, up through the field leadership, frankly, back to me. And so I think our commitment to our culture, our commitment to our people, the investments behind digital, the investments in our Food with Integrity approach and then, obviously, investments in food safety just positioned us really well. Obviously, having your dining rooms closed when we're a business that relies on people coming in the dining room to get food, we weren't sure how it was all going to play out. But luckily, people quickly adopted the digital off-premise occasion. And you guys have seen tactically what that's done for the business. That went from being, call it, 10%, 15% of the business all the way up to 80% of the business, and now it's running in the 40% to 50% range. And if you think about absolute dollars, one of -- I think it's amazing. Jack talks about this a lot. That went from being, call it, a $500,000 business to now well over $1 million business for each of our restaurants and in really short order. So the fact that we had the capacity to take on that size business and then we have the technology and the capability to service that business, I think has really paid big dividends for us as we get to the other side of this.

You're on mute.

You're on mute, Brian.

Sorry about that. Still learning the Zoom world. Well -- and on the -- drill down a little bit more on the digital mix. In July, you said the digital sales mix, it's obviously normalizing as dining rooms have reopened and said it's a little under 50%, I think, in July. I'm curious if you could drill down a little further on that and maybe consider markets where back-to-school and back to work is taking hold a bit more, traffic congestion and other metrics are sort of quasi normally -- normalizing. Where is the digital mix trending in those markets? And also maybe a comment on off-premise versus in-store sales mix in some of those markets that are unlocking.

Yes. I think we talked about this a little bit in our last earnings call. The -- what we continue to see is our digital business is very sticky. So as regions around the country come back at different levels, the good news, we're seeing our digital business is staying at 70% to 80% of where it, I would say, peaked, okay, even while dining rooms are coming back. In some places, only 40% of the dining room is back. In other places, we got 50%, 60% of the dining room business back. So -- and I think that's going to be a slow walk back because, frankly, every county, every municipality is taking a very different approach. One of the things we're tracking every day is what restaurants are allowed to have dining on the patio, what restaurants are allowed to have dining in the restaurant but only at 25% capacity, only 50% capacity. I don't think we have any dining rooms that are allowed to be open anything greater than 50% capacity. We still don't have a market where we're allowed to operate our dining rooms at full capacity. So with that said though, the good news is, as we see the dining room business come back, we definitely see that the digital business are different occasions. And as a result, those digital sales are staying pretty sticky. And I think the other indicator to that, too, is just the number of people now that are in our rewards program, we -- well over 15 million, closing in on, I think, like 16 million, not surprising. I believe we'll probably be at 20 million here in the not-too-distant future. And -- but I think that's an indicator of people not just visiting Chipotle one time but saying, "You know what, I want to be a part of the brand ongoing." And as we've looked at the composition of those rewards customers, a lot of them are new users. So -- and they've made the commitment to say, "I want to be in a rewards program," which tells you they're planning on making more than one purchase.

Yes, yes. No, that makes sense. And I want to ask about some of the pricing that you're taking and testing in the delivery channel. Our checks would suggest that you've been testing around a 7% menu price increase, give or take, versus your dine-in prices. And I'm curious if you're seeing any resistance. Is it shifting mix to mobile order pickup? And have you settled on 7% as the right number? Or are you still testing? Or really any other learnings that are worth highlighting at this point?

Yes. So I'd like to remind people just the history of our delivery business. Before COVID, we had -- I think it was a $3 delivery fee.

$3, yes, yes.

$3 delivery fees. And then obviously, when you look into the marketplace, there's a service fee that gets charged, and then you have the menu price. So you have these 3 components, right, menu price, service fee, delivery fee. And historically, we had not done anything on our menu price, and we were just experimenting with the delivery fee and the service fee and then like order minimums. And then COVID hit. And obviously, we took the delivery fee down to $1 and then, ultimately, I think, free and then we came back to $1. And where we are today is we are testing keeping that delivery fee still at $1, keeping our service fee constant. And our learnings have been the elasticity is very different for each one of those things, right? So the elasticity for a delivery fee versus a service fee versus a menu price is very different. So what we've decided right now is we're going to experiment on service fees, delivery fees and then menu prices. And what you've seen us experiment with most recently is the menu price. And that 7% doesn't get us all the way back to where we were with our $3 delivery fee proposition, but it definitely closes the gap. And we're going to continue to experiment because you've got these 3 different levers that I think are going to vary based on where you are in the country and arguably, maybe what your circumstances are. So I would say our experimentation probably will never stop in this space. And that's one of the things that I love about the digital business, you just get so much real-time data to better tailor the experience, both from price, menu offering. So that's why we're going to continue to experiment. But I think your observation is pretty accurate on the 7%. And obviously, we're testing a few other things as well. But we're seeing definitely different forms of elasticity based on each of those levers.

Okay. That's great. And I guess a follow-up on that. Just thinking about your store margin targets and how important is kind of optimizing profitability within the delivery channel. Can you frame -- you touched on it for a second there, but can you frame the pricing that you have taken at this point? If it's, say, 150 or 200 basis point delta right now versus, Jack, your 22% at 2.2, 25% at 2.5, say it's 150 to 200 bps that we're looking to make up, that 7%, does that get you half of that, 2/3 of that? Can you help parse that at all?

Yes. I mean listen, just rough numbers, ballpark idea, a 7% would probably return about 125 to 150 basis points of margin, something like that. So it helps close the gap. But to Brian's point, it doesn't close all the gap back to where we were charging $3 delivery fee without a menu price increase. And one of the things about elasticity that we're learning with the customers is when they are ordering in our app and they see that our burrito costs $8, that already includes the 7%, they know it costs $8. And that feels better to them than when they go through the whole process and at the end, they see the delivery fee and then they see the service charge as well. And so it feels like they'd rather see, as they're ordering, what's it going to cost you. And at the end, they like the idea it's only going to be $1 and then a modest service fee. So -- and that's what we're -- we're in the early stages. We're still learning what the customer response is going to be over a longer period of time.

Yes, yes. That's great. And I guess while we're on the topic of margins, a lot of companies in the industry during COVID have -- and outside of the industry, frankly, that have taken a deep-dive look at sort of their cost structures and operations to find ways to do more with less. And many of them obviously have been impacted by a greater degree than your business. But curious if there are cost savings or process changes that you've identified during this period, either at the store level or G&A that you think would stick on the other side as we're just thinking about the margin outlook post COVID.

Yes. And listen, Brian, to be clear, the extra costs of COVID are definitely higher than the savings. But there are a couple of areas that we are seeing savings, and we do think that some, maybe all of it will stick. I mean one great example at the restaurant level is, with the shift to digital, our food cost control is better, the idea of when somebody orders a burrito, the portioning is much, much, much more consistent. And each customer can order extra or light. So you still have the ability to go down -- like you're going down the line and say, "I want a little more rice, a little more salsa. I want corn and tomatoes." So you can do all of that customization. So we're not restricting what the customer is allowed to do, either in terms of portion or in terms of adding additional ingredients. But our portion sizes are much more consistent because there's not somebody pointing at every single pan and there's maybe -- the crew will see just the way that a customer is looking at them and think, "Oh, I better put another scoop in." So I think we're more consistent on portioning. And the other thing that we think is happening is when somebody adds something like guacamole or extra meat, they're getting charged every time. Like if you order extra steak, for example, the only way for us to make sure you get extra steak is you put extra steak, we put extra steak on and you're automatically charged for it. And so we're finding things like that are resulting in better controls at the food line. So -- and we do think, certainly, because digital will be more sticky, a lot of that will stay. But we also think it's an opportunity for us to get better execution on the front line as well as people order in restaurant. From a G&A standpoint, there's a couple of things that we learned. One, travel -- we don't need to travel as much. And we certainly want to have our folks get out in the field and visit restaurants. There's no substitute for visiting a restaurant and spending time with our team. But there are meetings that we bring people from around the country and you might have a 2- or 3- or 4-hour meeting, but it might take you 1.5 days -- or it takes everybody 1.5 days. We think we can have many more virtual meetings, so we think we'll have some savings in travel. And then we're also learning -- we had a number of open head count during this period, and most of them we didn't fill for obvious reasons. We filled the ones that were most critical. So we're learning about what competencies we do need to bring back and what competencies we can live without. So I think we can probably sharpen our pencil a little bit with G&A. So those are the things at the margin. Nothing dramatic, nothing like our total -- our model changes dramatically, but these are some of the benefits we expect to carry forward.

That's great. Before moving on to the next topic, I think a handful of markets -- just back to menu pricing, sort of core menu pricing, if you will. A handful of markets that we took a look at, it looks like, recently, you may have raised in-store prices a bit, maybe around 2%, which feels like a normal price increase, and we're getting close to that time frame, I guess, when you typically raise prices or at least start to in certain markets. And so I just want to ask, have you taken a recent price increase, which is towards that kind of normal pricing you would take in a year? Or maybe that was just some of the true-up in the markets that we touched on that I think you mentioned on your Q2 call.

Yes. I think it must have been the true-up, Brian. We didn't have any kind of broad-based menu price increase. We had a couple of minimum wage markets that we had some slight adjustments, but a very small number of restaurants, nothing broad-based.

Okay. Great, great. And I guess shifting gears a little bit, if we could, to the marketing side of the business. And during COVID, you've obviously leaned into digital and social channels. You've invested in free delivery, and you're seeing some huge sign-ups and really starting to leverage that loyalty program. And I guess the question I had is on the gains that you've seen in terms of brand awareness and just breadth of appeal during COVID. And can you talk about how you're tracking and how many new customers you think you've introduced to the brand? But also some -- any color on new occasions, how you're thinking about new occasions that may have been created, if you will, during COVID that you think can sustain in a post-COVID world? Maybe just help frame or quantify those 2 dynamics?

Yes, sure. So look, I think the best indicator is just the rewards program gains. Where were we at the end of...

I think we were like 8 million.

Right. Sorry, I thought the number was -- we're around 8 million at the end of 2019. Fast forward, what is this, 9 months later and we're now at 16 million, right? And it's just like that acceleration happened from March until now. I mean we were continuing to have growth in January and February. As -- you guys saw our results in January and February. We had double-digit comps with great transaction. But it just all accelerated from a digital standpoint. And what we are really optimistic about is the number of people in there that are new users. It's a really meaningful cohort. And what we have continued to see is -- the utilization of our analytics is we see that cohort, not only new users, but, call it, medium users, be impacted on their frequency of using the business -- or using Chipotle. And one of the obvious places we're seeing is more dinner business, more group occasion dinner business. So if you think about what are those new occasions that we're seeing, it's logical that you would see the new dinner -- group occasion dinner solutions, and we track this stuff. And the thing that I love to see is like the awareness that Chipotle has an app, Chipotle does delivery, that Chipotle is a good solution for a group meal. All those things have gone way up from an awareness standpoint. And then we're also seeing people actually using the brand in those areas that they're saying, "Now I'm aware of," continuing to go up. And I think we've been pretty purposeful. We've run advertising that shows the customization that you can have in the app, like Jack just mentioned. We want people to feel like there is no trade-off between being in line or online when it comes to Chipotle, right? Zero trade-off. So we've had to do some education. And the number of people -- now this is man on the street stuff where they're like, "Man, I used your app for the first time. It was so easy." That's a great sign. And we're seeing people repeat and then repeat again. And so we're very optimistic about what we're seeing with the new users into the business. At the same token, we've done a nice job, I think, of experimenting with access. And so Chipotlane is probably the most visible example of that, where we gave a new occasion to people where you can get Chipotle's food without getting out of your car. And we've got 100 of those now -- or more than 100, and the feedback on that has been just how convenient and fast Chipotle is, which, initially, when we were playing around with this, I'm like, "Boy, do you think it's really that much faster than just parking, going into a restaurant, grabbing it off the shelf and go?" And the answer is yes. It's perceived as a huge convenience benefit. So obviously, as that becomes a bigger piece of our business, that occasion will continue to be an incremental occasion for us, which today is contained to about 100 restaurants. So -- and then we're going to continue to do things from a menu and beverage standpoint and then continue to use the database to market to people to make them realize Chipotle is a great occasion on the weekends if you're a weekday customer and vice versa. So we've done a lot of good things.

Yes, that's great. And I guess circling back to the loyalty program. Some disclosures in your filings and some rough math around that would suggest that maybe 25%, if not 30% of your sales in Q2 or recent months are flowing through that loyalty program. Can you kind of confirm that that's in the ballpark? But maybe more importantly, speak to how you're leveraging incentives to impact behavior of that loyalty user base. And I'm sure it's still early days, but where are you on that journey?