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

Good afternoon, the clock just struck past lunch time. Thank you for joining us today. My name is Jeff Bernstein, and I'm the restaurant and food service distribution analyst at Barclays. I'm thrilled to introduce our next presenting company, Chipotle. With us this afternoon from -- mostly from Newport Beach, California, we have Brian Niccol, Chairman and CEO; Jack Hartung, CFO; and Ashish Kohli, Global Head of Investor Relations. By way of background, for those not familiar, Chipotle is what we would say, is the fast-casual pioneer with 2,900 or so U.S. units. Impressively, the year we're about to end 2021, costs are expected to be in the high teens. And unit development continues to be amongst the strongest in the industry, reaching high single-digit growth this year and something new to say is the vast majority of the new openings are featuring a drive-through. So with that said, I want to thank Brian, Jack and Ashish for joining us.

And I will kick it off with a few bigger picture questions and then a whole lot more specific to Chipotle. So with that said, just looking back, it seems like COVID has maybe accelerated the effect on structural changes that you might have been implementing for the past few years. I'm just wondering maybe, Brian, if you could talk about what's been the most transformative change for the Chipotle brand during this crisis, maybe both positive and negative things that have maybe accelerated due to the pandemic that might not have moved so fast otherwise?

Yes. Thanks, Jeff. And you're right. We were strategically already focusing on providing more access to the Chipotle experience via digital. And specifically, we have the app. We've got these mobile pickup shelves. We implemented a second digital make line, so that all digital orders don't interact with the frontline experience or the in-dining room experience. And we're making great progress, and we installed really the last, as far as the major initiative goes, the last digital make line and pickup shelves back in December of '19. And we saw an acceleration in our digital business in January, February of '20. And then, obviously, March of 2020, everybody knows what happened there. And accordingly, a lot of customers were forced to experience Chipotle via digital only because that was the only option. And I say good strategy, good timing, good execution, set us up to be prepared for the unexpected and unanticipated global pandemic. And we went from basically a $1 billion business to -- we'll finish this year somewhere north of $3 billion in digital sales. It was probably like mid-teens as a percentage of our business before COVID kind of became all our business for a couple of months. Today, we're settling in about 40% of our business. And the thing that's exciting, too, is at the same time, we launched a rewards program, which really put people into the full ecosystem of our digital platform. Today, we have 25 million people in that. If you kind of go back to pre-COVID, I think we were below 10 million, where we were around 8 million. So you can just see the acceleration that COVID really pushed on us. And we were fortunate to have that experience be in place and also our crews ready to be able to execute against it when that huge shift occurred. The other thing too is having now 25 million people in our rewards program, it's allowed our one-to-one marketing, our digital, call it data analytics to really grow tremendously in both how it can be used to drive the business, meaning run it from a forecasting, labor scheduling standpoint all the way to how we communicate with customers one-on-one. And we're on this journey of personalization ultimately. So I would say those were the big enablers that got just enhanced as a result of COVID. The challenges as it relates to COVID is not anything probably everybody on this call hasn't heard, right? It's been challenging to keep the restaurants staffed because when someone gets COVID, there's a lot of contact tracing that goes into place. We exclude people. And fortunately, the demand doesn't go down. However, our service gets challenged. And it's tough for the folks that are left in the restaurant because they're missing their teammates. And then it's tough to also hire people when these people only out for 7 to 10 days because they're being excluded. So it's not like you're replacing them permanently. So one of the things that kind of we've learned throughout this is that's been another, I guess, surprised benefit of having the digital business in the frontline business, is we're able to flex between the two based on where our staffing is and also based on whether there's a COVID flare-up or whatever other challenge might be happening in the market. So that's been kind of one of these hidden surprises that's been a net positive for us throughout these challenges. Supply chain and then the inflation in the supply chain is also a real challenge. I got to give a lot of credit to our supply chain organization. We've had no real disruptions and I think we've done a pretty good job of managing the inflation. And then obviously, you've got labor inflation as well. But the way we view it is, we're always willing to invest in good people. If in the long run, they stay with us, they grow with us, and they truly are committed to the Chipotle purpose around Cultivating a Better World. So a lot of positive things we've learned. And I probably should have started here too, the other thing that I really was impressed by is the strength of our culture, the strength of our people, because you've got to be really resilient to stay the course in kind of all the ups and downs that we've had over the last, call it, 2 years now.

I could only imagine how long it would have taken for you to achieve that digital success if it was not for the COVID variant, which -- the COVID pandemic, it just seems like it accelerated. And if you were ready for it, I mean it's great from our business perspective.

Yes, go down. I mean look, we thought we would get to this 40%, 50% range, but we thought it was years away, not months away. And you're exactly right. And I think as I've heard other people too, everybody seems to feel like it's COVID from a digital standpoint has been an accelerator to the tune of 3 to 5 years in behaviors.

Interesting. Right. And I'd be remiss if I didn't mention that there is a new variant upon us. So we're going through the [ Greek alphabet ] quickly. But how does your system prepare? Is there anything you have to do, I mean, come just a few days ago, is there a big meeting that has to happen? Or at this point is your system running operationally the way it should if there was a new variant coming more regularly? I mean how does -- or at this point, is it really not much of an impact at all?

Yes. I would say COVID has become a part of our weekly briefings. And we've amplified those briefings to go all the way into our restaurants. So the good news for us is we've got the right health and wellness practices in place. Our teams know how to execute against them as well as providing still a great culinary experience and great customer experience. And fortunately, all the variants really have not had any material change on the behaviors you have to execute to run a safe, healthy environment both for your customers and your employees. So obviously, I'm optimistic that more and more of our crew will be vaccinated over time. And I'm happy to say our leadership, as you kind of move from general manager to team directors to field leaders, we're in the 90% range now of folks being vaccinated, which -- and in some cases 100% depending on what level you get to, which I think also just gives our employees a level of confidence in going to work. And then you layer on top all the health and well-being things that we're doing from air filtration to masks. And look, I still don't really know what to think of Omicron variant. It sounds like it's contagious, but how severe that can -- the symptoms are as a result of this variant still are to be determined.

Yes. Right. And it does seem like over the past 20 months, a lot of restaurants, including yourselves, have talked about maybe being forced to do more with less from an efficiency standpoint or maybe benefits from a technology standpoint. And now we've got sales well above where they were pre-COVID. I'm just wondering, maybe for Jack. I know you guys have historically laid out x margin with y volumes, but is there a step function higher because of benefits that you've achieved over the past 20 month that -- I know people talk about maybe the margins wouldn't be as high as you previously thought, but is there an opportunity that they even better because of certain efficiencies in technologies that you've accelerated because of COVID?

Yes. Jeff, it's a great point because the digital system does lead to efficiencies. The idea that all those orders, we know about them ahead of time. We stage them. So our team is ready to deliver on the promised time of noon or 12:10 or 12:20. It's unlike the front line. In front line you need to have a fully staffed team regardless of whether people are coming in or not. So you have to have that fixed cost of labor during our peak time, whereas the digital system just automatically stretches the time out and we can serve many more people with less hours on that digital [indiscernible]. So that certainly helps us for sure. I think the only thing going forward that is a wildcard on margins is inflation and how much of it is -- and I'm talking wage inflation and ingredient inflation, and the debate continues about how much is transitory and how much is permanent. It feels to us like labor inflation or at least the step-up from labor is permanent. I don't think it will be forever that the labor will go up at this rate, but it's going to stair us up to another level. Ingredient inflation, I think some of that will be permanent. Some of that, I think that's related to just the supply chain being choked off where they're just not enough drivers or not enough trucks or they can't get into the ports. That will resolve itself over time. So I think there's going to be that part of the margin equation that still has to play out. But generally, yes, we like our chances and we have the ability to drive high margin normally in our system but then when the business shifts more towards digital. And as we open up more Chipotlanes, our customers shift even more towards that convenience channel that allows greater opportunity for efficiencies and greater opportunity for margin expansion.

But the fact that the digital mix to be so much higher, so much quicker, which would be a positive for margins. I know people have always hung their hat on your 2.5 million AUV is a 25% margin, and now the talk is the 3 million AUV. But the positives and negatives, it doesn't seem like that a 30% margin would come with that 3 million AUV despite the efficiencies you're getting from the digital aspect of it, there would be other headwinds that would still make that difficult to match up for the 30%?

Yes, it mathematically won't, Jeff, and mainly because of what's happened. And I think a good example is what we did in the second quarter where wage inflation was soaring at that point, and we needed to make a bold move so that we could retain people in our restaurants and then make sure we had [indiscernible] flow. The world really changed in terms of the labor market for everybody. We know that in the second quarter. The price increase that we took at that time did raise -- we took a 4% price increase that will raise our AUVs by $100,000. But we're not making margin on that 4% price increase. All we did was keep our profit dollars the same. So you're basically talking about taking the same profit dollars on a higher sales. And so that does push just mathematically instead of a high 20%. Like a 3 million before all this would have generated maybe a 29-ish percent margin. That number is now going to be more in the 27-ish percent range, something like that. But it's more mathematical. And the thing we're not going to do is, yes, we're going to navigate and deal with inflation, whether it's ingredients and whether it's on the labor side of things. We're going to preserve profitability, but sometimes that means the margins are going to slip a little bit. But if we can earn the same or better profit dollars, while we're navigating through this inflation environment, we think that's a very positive outcome.

Understood. Right. For Brian, I mean, the 2-year stack above 20% through 2021 is obviously incredible. I'm just wondering if maybe you can prioritize more on the fun side of things in terms of the initiatives that have the greatest impact on sustaining that momentum in '22? A lot of people just look at comparisons and say it's going to be very difficult for you. But how would you prioritize between the products and the loyalty and the digital? I mean, there's so many different things you got going on there. How would you prioritize those different levers you have to play in 2022?

Yes. Look, I can understand why people would look at the comps and say, wow, that's difficult to do, because nobody is doing the comps like we are. But I think that's a testament to the strength of our brand and the strength of our strategies, and frankly, the strength of our organization. So as I look forward, there is still upside in what I've talked about probably from the very beginning on our operating model, which is just getting better throughput on the front line. And then also getting better execution in our digital business on accuracy and being on time. We know if we get better with throughput, we move the line faster and people are willing to get in line. When they see the line get to a certain distance, they walk by our line. And I love to see the lines that are back, but I wish they were moving faster. And so our operators are very much focused on retraining people. Because the other thing you got to remember, too, is unfortunately, one of the starts and stops of COVID, we've got a lot of employees that have never run a frontline with a real lunch-type business experience. And we're starting to see that come back. We're getting our people trained on the 7 pillars of great throughput. And then same thing goes on the digital business. It's one of those things where if we can be more accurate, more on time and obviously go faster, we can provide more people the time slot that they want to get their food, right? If you go onto our website or the app and you want lunch at 12:00, you're probably willing to order a 12:10 or 12:20 or 12:30. But if it's not available until 12:40, you're probably out. So that's why I believe there's still so much more upside in just our operating execution. There's obviously upside in what we're doing for from a marketing and menu standpoint. If you remember, when we started this, I couldn't believe that we were spending 3% of sales on marketing because I felt like the brand was invisible. And now we're spending 3% on marketing and when I talk to folks, they think we're spending 5%. They think we're spending 2x, 3x the amount of dollars that we're actually spending because I think our marketing and digital team is doing a phenomenal job of getting the Chipotle brand in front of people at the right time with the right message. And that budget has grown. We've held the percentage flat. But now that we're north of 2.5 million average unit volumes, obviously, that marketing budget grows accordingly. And we've added hundreds of restaurants. So you definitely have more marketing dollars going to work. And the way we're putting those dollars to work is through menu, communication and digital. And then obviously, the whole analytics area. The fact that we have got this database that a year ago, it wasn't 25 million. A year ago, I don't know what it was, but maybe it was 18 million. We just have more people with more information and we're getting better and better at figuring out how to influence behavior based on the information that we're collecting. And I think when you line those things up, we feel we've got a lot of room to continue to grow our comps. And what's also really exciting is as we open these new restaurants, we're seeing very little impact to our existing restaurants. So the new units that we're opening are not causing a drag on our existing units. Actually, what we see is people are more excited because it's more convenient now to have more access to Chipotle, both physically and digitally. So that's why we continue to be really confident in our ability to comp the comp and go after this $3 million-plus average unit volumes, while we build over 200 restaurants a year.

Got it. And I get the feeling investors get excited by new product news. Obviously, the quesadilla was a big one. Yes. So what excites you over the next 12 months? What are kind of different opportunities, whether it's new protein or new menu item completely or add-ons or anything along those lines that are kind of further along in the stage-gate process that we should start to wet our [indiscernible] on?

Yes, sure. Well, if you've had the opportunity to travel at all to -- like at Sacramento or Cincinnati, you might have tasted some of these products. But we recently tested plant-based Torito, which did really well in test. And it's consistent with, I think, the consumer trend of wanting some plant-based alternatives. So we're excited about that one. We have in test right now [ pollo asado ], which is the first time we put a new marinade on our chicken. And I think you've heard us talk about this. We want to always figure out how we can improve our core menu. And one of the -- there's a group of people that find our chicken a little spicy. But I think that's also part of the reason why they love it. So this [ pollo asado ] gives you another flavor profile that's in test right now, a couple of weeks in, performing really well. So we feel really good about that one. We're working on additional steak products. And obviously, we just finished doing brisket. We're still working on some beverage innovation, and we're continuing to work on some dessert innovation. So we like the pipeline. I think we've said this before, 2 to 3 things a year seems to be plenty. It keeps people engaged. And at the same token, I think it helps us be seen as both a leader and being relevant in culture. And that's what we want to be doing.

And I feel like I can visualize myself standing in the line. Obviously, it's not a very long line. So when you talk about adding new items like how do you -- I mean, obviously, all those different things will be exciting, but there's just not enough room for all them. How do you operationally handle, adding something new? I mean do you always have to remove something? Or how do you -- or are some of these things just going to be second makeline-only?

Well, so yes, some of the things we just talked about here would be limited menu offerings. None of those items are planned to be permanent. And it's for that reason, Jeff. When we test, one of the big things we're looking at from a testing standpoint is the operational impact of the product. We never want to impact our ability to cook chicken on the grill because now we're cooking cauliflower rice, right? So we want to make sure our forecast is right. We want to make sure that the teams can execute so that the customers get the experience that they want. So we're very -- that's why we use the stage-gate process. We're very disciplined about it.

Right. Clearly, obviously, comps excite people, but the unit growth is the stable, steady platform that drives your revenue growth. So I mean, it seems like you're approaching 3,000 units in the U.S. I think your prior target for long term was 6,000. So simple math, that would be halfway there. Is there something that tells you now that there's an opportunity, whether it's for -- whether it's your Chipotlanes or whether it's just other more digital-oriented customers that lead you to believe that 6,000 is kind of a halfway point before you push it to 8,000 or 10,000? Like how do you kind of gauge when you should reassess how many units you could have domestically?

Yes. So we look at it a couple of ways. One, the performance of our restaurants on kind of population, right? So we have some markets where we're more penetrated than others, and we continue to open in those markets. So as we continue to see performance in like Ohio, it gives us confidence that, okay, you know what, you can have deeper penetration with Chipotle and get the economic performance that we want. The other thing that we are doing is we're testing small town formats. We're testing Chipotlanes only. We're testing digital kind of forward restaurants, [indiscernible] restaurants. And the reason why we're testing these things is we just want to understand, it's more of like a validation intuitively what we believe will work. But I think we prefer to make sure we know the implications of doing those things before we start putting them out there and saying, this is the plan forward. The good news is the small towns that we've opened looks like they really like Chipotle in small towns. And when we do these Chipotlane only, we're only a couple of weeks in on some of these, we're not seeing really any impact to the existing Chipotlanes that we have there. So it's a great kind of fill-in approach. So I'm pretty excited about the idea of going from 3,000 to 6,000. But obviously, we've got irons in the fire to understand how do we go beyond that. And when the time is right, we'll share where we go beyond 6,000, but I'd be pretty happy with going from 3,000 to 6,000 here in the near term and then figuring out how we have additional passive growth.

I'm not sure whether you'll still be there when they hit 6,000. That seems like you still have -- you have a lot of runway to go to get from 3,000 to 6,000. So...

I don't know where you're sending me, Jeff, but...

No, no, I'm just trying to do quick math in my head and looking at a lot of years. But how do you -- how does that come into play when you think about the unit growth because many years ago, when you were smaller, you could have done 10% unit growth. But now at 3,000 units, you had been doing 5% unit and now it's -- you're actually inching it back up again. So what is the gauge that dictates how many units you would open next year or the year after? Is it real estate's a getting factor? Is it people? Or just you just can only open up some [ lanes ]?

It's actually -- the good news is the economics and the real estate are all there. And as we get bigger, this is kind of one of things that's interesting, as we get bigger now when we have like 3,000 restaurants, we have the ability to have more apprentices, more general managers ready to go to staff the new restaurants that we build. So it's not surprising that you're going to see us continue to inch up our new restaurant builds as our base gets bigger because we now have a bigger base of talent. And having the bigger base of talent is really what we want to make sure we have so that to make it up, you go from 250 to 300 to 350. Well, it does us no good to open 350 if I don't have 350 general managers ready to go. So having a bigger base helps us open more restaurants. And so that's why you're seeing us kind of every year be able to step up the units that we build. And I love the progress that we've made, and I think we demonstrated that as we keep stepping up the development, we've got the people pipeline, and clearly, the economics insights have not wavered at all.

So it seems like people is really the guardrail that would stop you from saying next year, let's just open up 500?

Well, yes, I mean it also -- it's like I wouldn't want to do something like that because that just seems like you're kind of jerking the system around. I'd rather be more paced in our approach. But to your point that's a number that someday maybe we do open that amount, but it's like we're not there now.

Yes. Right. And when to talk about pricing, just maybe in the traditional restaurant, how do you balance what the right price increase is? Because presumably, you have a pricing power to take enough to fully offset all of your inflation, but then some would say, I'd rather take less. This is an unusual environment. I want to maintain our value proposition. I feel like you also have that hurdle of maybe you're approaching a $10 level, which maybe is a psychological level for people. So how do you think about what the right amount of price is in restaurant? And then maybe, obviously, we've talked about delivery as well. But just thinking about the parameters around pricing?

Yes. Look, I think the good news is I don't think there is a barrier at $10 for our experience. When you think about the food, quality, the customization and speed that value proposition goes well beyond $10. And I think we've chosen to be very cautious on how we use our pricing power because we like having it. and we like having the strong value proposition. And when we need to do it, we do it. And the good news is we don't see really any meaningful resistance to that. And our march is going to be always trying to figure out how we can eliminate any costs that are unnecessary, figure out how we can be more efficient so that we can continue to have a really strong value proposition. And when I look at people that are kind of in our space. The reality is, it's like -- there are salad places, you're paying $15 plus for salads and I'm seeing some of the sandwich places where you're in that $15 range. And so when I stop and look at our chicken burrito, there are moments where I'm like, Geez, we are way underpriced. But then I love having that position of being able to be the value leader as well as the quality leader. There aren't many places that have that luxury, and we happen to be a company that has that. So it's important to us.

From a consumer perspective, the fact that you've been a value leader for such a long time, makes it then hard to really get what you probably deserve for as a price point for burrito. So it's kind of stuff there. But obviously, if the economics work, it's working for everybody. So...

Yes, I wouldn't say we're stuck, Jeff. I mean this is our choice because we want to continue to grow our user base, grow market share and give more and more people access to what real food, real culinary is all about. I don't feel like we're stuck at all. If we wanted to move, we could, and I think the consumer would come with us.

And then Brian, just to back that up, we never see resistance or any meaningful resistance. And that's all throughout the years, and that's with delivery. So I think that's a good indication that while we've maintained great value, when we've taken a price increase, customers are like it's still a great value. I mean you just can't get this kind of quality in food at any other place out there. I mean Brian mentioned the $15 salads and $12 sandwiches and stuff like that, Chipotle's still a great value.

Absolutely. Right. And then in terms of the -- you mentioned the loyalty program, again, 25 million members pretty quickly. Just wondering how you'd characterize the learnings from that? And maybe what elements do you think offer the greatest potential? Just trying to figure out what the ultimate success level is from that loyalty program? Like how do you define success with that program?

Yes. I mean, look, the way we define success is we want to be influencing behaviors. And specifically both the purchase frequency of those that are in there, the light, call it, lapsed users that you see come in and out. And I'll tell you what, the guys did a great job. We just launched this new rewards revamp, where you can now redeem points at much lower levels for like chips and guac; and chips and queso versus having to wait until you get a full entree. And the thing that's been really exciting in this is it's getting more engagement out of those light users. And so we're really excited about seeing how it's having a behavioral impact on those light medium users, while our heavier users are still taking advantage of stocking up to get the free burrito. The other thing that's nice, too, is these lower points, they end up redeeming on better margin. Rewards is the way to think about it, right? So you're ending up providing less of a discount when they end up redeeming those points earlier. So it's working both ways. We're getting more engagement, more frequency and we're getting some better economics on how they turn their points.

I would think if you engage a customer and they know they could turn it around more quickly that kind of keeps them engaged and coming in more often potentially.

Totally. And I would have never guessed it, but a lot of people like to save their points to get Chipotle flip flops and which is also amazing. So that's great too.

Yes. Well, with my 30 seconds left, I'm just curious from a cash usage perspective, I mean, Jack, how do you prioritize those decisions? I mean, obviously, you've got a lot of investment opportunity in terms of your own growth or presumably you're generating a lot of cash. So how do you balance that with the return of capital? I know you do some periodic share repurchase, but the flux of ever doing a dividend or anything along those lines? Like how do you make that balance?

Yes, Jeff, we get this question a lot, and it's pretty much we're staying to the playbook of, we've got a lot of growth ahead of us. So having a liquid balance sheet is really, really an important bit. It really paid off during this pandemic. And it doesn't make any sense for us to get too cute with the balance sheet, cut things so tight because then when you hit a bump in the road like we just did with the pandemic, you now all of a sudden have a more difficult time making the right long-term investment. What I love about during this pandemic was our purpose and values really came to light. We were able to sit down and make important investments in our people, in our food, in technology, without worries about do we have enough balance sheet, do we have to go to the bank and get this kind of funding. So we'll want to maintain that flexibility going forward. Having said that, we will take excess cash flow. We'll buy back stock. When our stock happens to be under pressure, which the whole market has been volatile over the last month or so, we really take opportunities at that time to take advantage of that. No current plans for dividend. And mainly, Jeff, that's because once you start a dividend, it's an annuity now that you have to keep going. We don't believe that it makes sense to do a special onetime dividend. So we're not really at that stage. I do think there's going to be a future where we still have a lot of growth left that we can sell fund -- that we can buy back our stock, and we can probably at some point pay dividend as well, but I just don't think that time is right now.

No, totally understood. You're making me very hungry for lunch, and we been going through our 35 minutes. But I want to thank Chipotle for joining us today. Brian, Jack, Ashish, thank you so much. Hopefully, you have a good day of productive meetings. We will see you in a couple of those and otherwise, have a happy and healthy holiday season.

Thanks, Jeff. Same to you.

Thank you.

Thank you, guys, very much.