Chipotle Mexican Grill

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1 April 20, 2012 Consumer Goods Chipotle Mexican Grill Ticker: CMG Current Price: $ Recommendation: HOLD Implied Price: $ Key Statistics 52 Week Price Range 50-Day Moving Average Estimated Beta Dividend Yield Market Capitalization 5-Year Revenue CAGR Trading Statistics Diluted Shares Outstanding Average Volume (3-Month) Institutional Ownership Insider Ownership EV/EBITDA Margins and Ratios Gross Margin EBITDA Margin Net Margin Debt to Enterprise Value Leverage Ratio $ $ $ N/A B 44.70% million.484 million 100.7% 1.68% 28.13x 25.96% 20.97% 20.57% N/A N/A Investment Thesis Chipotle Mexican Grill is a firm with a strong business model, focused growth strategies, and impressive brand image that it has successfully leveraged into consistent growth over the past five years. CMG has experimented implementing its business model into other cuisines and if successful, could introduce Chipotle to new markets. CMG s Food With Integrity initiative appeals to growing consumer preferences concerning responsibly raised ingredients, healthy menu options, and environmental sustainability. We recommend a hold because the market has already priced in much of the firm s domestic growth, but aggressive international expansion presents a tremendous upside. $ $ $ $ $ $ $ $ $ $50.00 Chipotle Mexican Grill (5- Year) $0.00 Nov-08 Mar-09 Jul-09 Nov-09 Mar-10 Jul-10 Nov-10 Mar-11 Jul-11 Nov-11 Mar-12 Price 50-Day Avg 200-Day Avg Covering Analysts: Jacob Friedman & Jack Roeder 1 University of Oregon Investment Group

2 Average Revenue (millions of $) Number of Restaurants University of Oregon Investment Group Business Overview Number of Restaurants Comparable New Steve Ells, a graduate of the Culinary Institute of America, founded Chipotle Mexican Grill, Inc. (CMG) in 1993 in Denver, Colorado. CMG offers a focused menu of burritos, tacos, burrito bowls, and salads in its 1,230 company-operated restaurants across the Unites States, Canada, and the UK. The 1,230 restaurants also includes one ShopHouse Southeast Asian Kitchen, which is a new concept restaurant that follows the Chipotle format but serves cuisine inspired by Thailand, Malaysia, and Vietnam. The first ShopHouse was opened in 2011, and CMG plans to open another in 2012 due to the success of the first restaurant. The ShopHouse test concept will be discussed in greater detail later in this section. Chipotle Mexican Grill The company began as a single restaurant near the University of Denver campus, where it quickly became successful. In 1998, McDonald s made an initial investment in the firm, and eventually became CMG s largest investor by This involvement by McDonald s enabled Chipotle to rapidly expand from just 16 restaurants in 1998 to over 500 in McDonald s fully divested from CMG in 2006 as part of an effort to focus more on its core business. CMG went public on January 26, 2006 when it began trading on the NYSE under the ticker symbol CMG Average Revenue per Restaurant Comparable New Chipotle manages and operates restaurants in six different regions that combine into only one reporting segment. Revenue growth is driven by increasing repeat customer visits to existing restaurants and through the addition of new restaurants. Once a restaurant has entered its thirteenth month of operation, it is called a comparable restaurant. Chipotle analyzes its performance and projects its future growth by dividing its restaurants into two categories: comparable restaurants and new restaurants. Data concerning the past performance of these two resta urant categories can be found to the left. Increasing comparable restaurant revenue is important to CMG because comparable restaurants tend to have higher margins than new restaurants. ShopHouse Southeast Asian Kitchen CMG believes that the format used in Chipotle restaurants can be successfully adapted to other cuisines. This special format includes: Finding the best sustainably raised ingredients. Preparing and cooking food using classical methods in front of customers. Serving customers in an interactive format by great people. As noted above, CMG s first attempt at extending the Chipotle restaurant model is ShopHouse Southeast Asian Kitchen. The first was opened in 2011, and serves rice or noodle bowls and banh mi sandwiches. Even though CMG plans to open an additional ShopHouse in 2012, the company s focus remains on building and developing the Chipotle brand. Overall, CMG is a firm that is very conscious of the value of its culture and brand, and makes strategic decisions to maintain and leverage this brand equity to grow in deliberate ways. UOIG 2

3 Strategic Positioning CMG operates in the limited-service restaurant industry, which includes a number of fast-food restaurants and grocery stores. However, CMG is determined to change the way consumers think about fast food. Inspired by attributes of fine dining, CMG employs a number of strategies that set it apart as a limited-service restaurant. The following subsections highlight a few of CMG s core strategies for differentiating their brand. Food With Integrity CMG s core philosophy of Food With Integrity goes deeper than offering its customers high quality ingredients. Chipotle s focused menu allows the firm to carefully examine where each of its ingredients comes from and select the best suppliers for the CMG and its customers. This includes naturally raised meat (no growth hormones or antibiotics), sustainably/organically-grown produce, and dairy prod ucts from cows with access to pastures. CMG has faced some challenges while pursuing its Food With Integrity initiative because these products can become extremely expensive or can be abandoned by farmers altogether during difficult economic times. For example, some of its restaurants served conventionally raised chicken and steak during the beginning of 2011, but all restaurants were serving naturally raised meat at December 31, In spite of these issues, Chipotle is fully dedicated to providing its customers with high quality ingredients that are raised or grown responsibly. Culture of Top Performers Chipotle further seeks to enhance its customers experience by hiring the best employees for all positions within the company. CMG attracts and retains quality people by offering attractive long-term career opportunities. Impressively, more than 97% of salaried management and over 98% of hourly management have come from internal promotions. Of these res taurant managers, the best are promoted to the title of Restaurateur, where they are capable of earning additional bonuses for empowering and developing other employees. Restaurateurs are granted increasing responsibility over additional restaurants until they prove that they show that they are capable of producing highly motivated, top-performing teams. At this point, Restaurateurs can be promoted to Apprentice Team Leaders where they are granted further responsibilities and employee benefits. When developing management and in-store operations, CMG stresses the importance of method and culture, the front line of employees that customers interact with, and sticking to the basics that have made the company successful. Close Relationships with Suppliers Because high quality, responsibly produced ingredients that can be delivered at reasonable prices are vital to Chipotle s philosophy, the development of close relationships with suppliers is an integral component of its strategy. As a result, suppliers are examined closely and selected carefully based on their ability to comply with the strict requirements of CMG. Once a supplier is chosen, CMG seeks to build a longstanding, mutually beneficial relationship so that it can reliably source its ingredients and other inputs. UOIG 3

4 Business Growth Strategies CMG has experienced substantial growth over the past five years. This has been driven by increasing revenue in existing restaurants and by opening new restaurants around the United States and some abroad. As a result, CMG s growth has been entirely organic, and the company plans to continue this trend in the future. CMG s growth strategies are focused and deliberate, allowing the firm to maintain control of its valuable brand image and build a strong following of loyal customers in attractive locations. The following sections will discuss Chipotle s growth strategies in terms of domestic operations, international operations, and business model extension to new brands. Domestic Growth This continues to be CMG s main growth focus. With strong new restaurant openings over the past five years, CMG expects to open an additional restaurants in Management has also stated that there is no shortage of quality locations in the United States, so market saturation is not an issue Chipotle is facing at this time. It is also important to note that many of the new restaurants that CMG plans to open are what the company calls A Model restaurants. A Model restaurants are restaurants opened in secondary trade area locations with attractive demographics and lower investment and occupancy costs. Geographic Distribution of CMG s Restaurants Country Number of Restaurants United States 1,226 Canada 2 UK 2 In addition to opening new restaurants domestically, it is also important for CMG to grow existing (comparable) restaurant revenue. CMG does this by increasing repeat customer visits through advertising, employee training, and exemplary customer service. Chipotle has also introduced its Farm Team, which is a customer loyalty program that is slightly different. Instead of incenting customers to purchase Chipotle products as often as possible, the program encourages members to be ambassadors for the Chipotle brand by personifying the company s values and mission (Food With Integrity). International Growth CMG s international growth strategy is still under development. Curren tly, CMG has two restaurants in Canada, two restaurants in Great Britain, and plans to open one restaurant in Paris, France in These restaurants have been successful in their respective markets, and Chipotle plans to continue expanding abroad. However, this process has been slow, steady, and focused because the company does not want to make any mistakes that may damage its brand image on a global scale. Overall, international growth expansion remains a huge growth opportunity for Chipotle in the future. Business Model Extension CMG believes that its business model and philosophy are extendable to a number of different restaurant types and cuisines. This can be seen through the introduction of the first ShopHouse Southeast Asian Kitchen in Washin gton D.C. in This restaurant has been very successful, and CMG plans to open a second ShopHouse in However, CMG has not projected that ShopHouse will contribute to the company s overall growth in the near future, as it is still a test concept. As a result, growth as a result of business model extension is not part of CMG s current growth strategy, but may play a major role as the UOIG 4

5 Consumer SPending (billions of $) Industry Revenue (millions of $) University of Oregon Investment Group Types of Limited-Service Restaurants Cafeterias/Buffets Drive-thru Off-premises On-premises Industry Revenue $172,000 $170,000 $168,000 $166,000 $164,000 $162,000 $160,000 $158,000 $156,000 $154,000 $152, Chipotle format gains popularity and ShopHouse shows continued signs of success. Industry Overview CMG competes in the limited-service restaurant industry (also known as the fast food industry). This industry includes: cafeterias and buffets, drive-thru limitedservice restaurants, off-premises (take-out) limited-service restaurants, and onpremises limited-service restaurants. At limited-service restaurants, customers pay for their food before consuming it. Additionally, customers often have the option of eating their food at the restaurant, taking it to go, or purchasing it through a drive-thru. Business models tend to be simple, with firms either franchising or directly owning the restaurants they operate. Some companies within the industry own a number of different limited-service restaurant chains, which often offer different types of cuisines. Additionally, many of the larger firms have seen high levels of restaurant saturation in the States, and have looked abroad to sustain and increase growth. As a whole, this industry has struggled over the past four years as the recession hurt consumer spending. Consumers were less likely to eat out at fast food restaurants, and decided to eat at home instead. In 2010 and 2011, the economy has displayed signs of recovery, including strong increases in consumer spending. Overall revenue growth in the limited-service restaurant industry has seen growth in line with this increase in consumer spending. The following sections will discuss the key drivers and analyze the degree of competition in this industry. Key Drivers The three key macroeconomic drivers of success in the limited-service restaurant industry are consumer spending, consumer preferences, and commodity prices Consumer Spending 2008A 2011A 2014E 2017E Consumer Spending The recession caused an increase in unemployment, which resulted in a significant decrease in consumer spending. This had a largely negative effect on the limited-service restaurant industry, resulting in an average annual decrease in revenue of 1.6% over the past five years. As the United States (and the rest of the global economy) emerges from the recession, consumer s pending is projected to increase. This will have a positive effect on players in the limited - service restaurant industry, with a projected 2012 increase in revenue of around 2.1%, a growth rate that is expected to continue through Consumer spending also reflects changes in disposable income and consumer sentiments. Both of these drivers are expected to slowly increase in the coming years. As the consumer sentiment index increases, consumers become more confident spending more of the disposable income. Currently, the transition from a recessionary period (where many consumer chose to eat at home) to a recovery period will benefit the limited-service restaurant industry because these restaurants offer low cost, convenient meals. Further increases in the consumer sentiment index will cause a shift toward more expensive, fancier restaurant choices. UOIG 5

6 Percent Change Percent of Average Diet within Guidelines University of Oregon Investment Group Consumer Preferences As with almost all industries in the consumer goods sector, the limited-service restaurant industry is highly dependent on the preferences of consumers. Recently, consumers have shown a preference for more health cons cious and internationally varied food options at limited-service restaurants. 74% 73% 73% 72% Healthy Eating Index Consumers are becoming increasingly aware of the unhealthy nature of many fast-food chains, and are demanding more healthy options. Even though many limited-service restaurants have responded to this trend by offering more healthconscious items on their menus, this trend has had an overall negative impact on the typically unhealthy limited-service restaurants. However, consumer diets continue to be poor, and the healthy eating index (measured as a percentage reflecting the degree to which Americans stick to the consumption guidelines set out by the USDA) is expected to continue decreasing in the near future. 72% 71% 71% 70% 2008A 2011A 2014E 2017E In spite of this trend, consumer awareness about health issues surrounding fastfood restaurants is expected to be a significant trend in the industry, and the most successful limited-service restaurants will be able to successfully adapt their brand images to align with the health preferences of consumers. This has led to the emergence and popularity of the fast-casual segment of the limitedservice restaurant industry. Customers of fast-casual restaurants still seek convenient and affordable meals, but tend to care more about the origin and preparation of the food. Limited-service restaurants have also diversified into a variety of specialty and ethnic cuisines in order to match the preferences of consumers. For example, McDonald s has begun serving specialty coffee drinks in their fast-food restaurants. Much of this success has been found in international markets (especially China), and these specialty and ethnic options have largely outperformed the rest of the industry Producer Price Index Food Commodity Prices The limited-service restaurant industry is highly dependent on commodity prices because food ingredients are the main input for their products. As a result, many of the players in this industry enter into contracts and strong supplier relationships in order to ensure a reliable source of inputs for their operations. Increasing global demand has caused commodity prices to increase on average, and this squeezes margins for the industry as a whole. The companies within the industry that are able to leverage their brand equity to increase prices without losing business will be better able to cope with rising commodity prices It is difficult to project how commodity prices will behave in the future for the purposes of valuation. Although commodity prices may rise in general, not all commodity prices move in the same way. As a result, a company that is exposed to a large number of commodities may experience moves in the price of some commodity that are offset by an opposite movement in the price of a different commodity. Competition Competitors in the limited-service restaurant industry include cafeterias and buffets, on-site limited-service restaurants, drive-thru limited-service restaurants, and off-premises limited-service restaurants. The major players in this industry include McDonald s Corporation, Yum! Brands, Inc., Doctor s Associates, Inc. (private owner of Subway), Wendy s International, Inc., and Burger King Corporation. UOIG 6

7 Market Share Breakdown The major bases of competition between players in the limited-service restaurant industry are price, location, variety, brand, and service. Since patrons of fastfood restaurants usually seek quick, convenient, and cheap eating options, the limited-service restaurants that can deliver these attributes the most profitably to consumers are the most successful. Companies also benefit from brand awareness and equity, which is increased through effective marketing and franchising. Franchising (or operating as a multi-establishment restaurant such as CMG) has become increasingly important in this industry, especially through the recession, because it allows firms to reach economies of scale and increase profitability. In 2010, franchised and multi-establishment companies accounted for 65% of industry revenues, while only accounting for around 10% of total establishments. McDonald's Yum! Docotr's Associates Wendy's Burger King Chipotle Other In general, concentration within the limited-service restaurant industry is very low. In fact, approximately 48% of operators within the industry are small businesses with nine or fewer employees, and the five largest firms in the industry only control approximately 38% of revenues. Concentration within the industry has increased recently as firms attempt to increase profitability, market share, and financial flexibility. For example, Wendy s and Arby s merged in 2008, but Wendy s sold off Arby s to a private equity firm in Private equity firms have also acquired Burger King and California Pizza Kitchen in recent years. Overall, industry concentration is expected to increase slightly over the next five years. Management and Employee Relations CEO Steve Ells Steve Ells, Chairman and Co-CEO Mr. Ells founded Chipotle in Prior to Chipotle, Ells worked at Stars restaurant in San Francisco for 2 years. Ells was the vision behind Chipotle success, asserting that food served fast does not have to be low quality. Ells graduated from the University of Colorado with a Bachelor of Arts degree in Art History. He is also a graduate of the Culinary Institute of America. His 2010 salary was approximately $1.2 million. Montgomery F. Moran, Co-CEO Mr. Moran was appointed to Co-CEO in 2009 after serving as COO for 4 years. He previously served as CEO of a law firm in Denver. Moran was the initiator of the Restaurateur program. Moran received his Bachelor of Arts in Communications from the University of Colorado. He later obtained a law degree from Pepperdine University. His 2010 salary was approximately $1 million. John R. Hartung, CFO Mr. Hartung has been the CFO since Prior to Chipotle, Hartung held several management positions at McDonald s Corp. In addition to the finances,, Mr. Hartung overseas IT and security at Chipotle. He received a Bachelor of Science Degree in Accounting and Economics as well as an MBA from Illinois State University. UOIG 7

8 Recent News April 18, 2012 Can Chipotle s earnings continue to fire up the stock? (Forbes.com) Analysts are cautious on their outlook for CMG s stock as rising food prices may squeeze margins. As a result, many analysts have slightly lowered their estimates for projected EBITDA. However, consistent new restaurant openings are projected to continue into the future. Analysts are also still waiting to see how well received Chipotle restaurants are in international markets because this will be a huge growth opportunity for the company going forward. April 18, 2012 Dark meat chicken surge spurs shortages, price hikes (InvestorPlace.com) Consumer preferences have shifted toward dark meat chicken (leg and thigh meat) as a result of several cooking shows and other cooking media promoting the taste. This has resulted in shortages in chicken leg meat, which has caused price increases. Although CMG offers mostly dark chicken meat that appeals to consumers, it is also required to pay slightly prices for this meat due to the shortages. April 16, 2012 Chipotle Mexican Grill Responds to FDA s Voluntary Plan to Reduce Antibiotic Use in Farm Animals (InvestorPlace.com) Chipotle applauded the FDA s recognition of the use of antibiotics to stimulate growth in livestock. However, they would like to see more done to further prevent the use. The plan also would require a prescription to put antibio tics in feed. Ells, the founder, stated, These voluntary guidelines seem unlikely to cause producers to change the practices that necessitate dependence on drugs in the first place. It s an important first step, but stronger action will be needed to bring about meaningful change in an industry where their practices are so well entrenched. This press release is an indicator of Chipotle s ongoing effort to promote Food with Integrity. Chipotle continues to promote its dedication to naturally raised meet. It currently provides more naturally raised meats than any other restaurant in the nation. Catalysts Global Industry Sales Breakdown North America Europe Asia South America Oceania Africa & Middle East There are many macro and micro factors that can influence Chipotle s future cash flows. Below are both upside and downside catalysts that, if realized, will affect the share price of Chipotle. Upside Successful restaurant launches abroad could significantly expand CMG s potential market. The ability for Chipotle to replicate its business model into other food genres could catalyze growth in other markets (such as ShopHouse Southeast Asian Kitchen). If certain commodity (beef, chicken, produce) prices decrease, it could expand margins. Chipotle s ability to establish relationships with high integrity suppliers could allow them to reduce food costs while ensuring the ability to obtain goods. UOIG 8

9 Consumers becoming more conscious about the foods they eat could bring attention to Chipotle s Food With Integrity business model and garner more loyal customers. Downside The rejection of Mexican Food or other offerings abroad could limit CMG s international growth. If Chipotle is unable to successfully integrate its business model into other genres of food, its resources would be wasted and growth hindered. If commodity prices rise, Chipotle s margins will be squeezed in the current business model. Because of Chipotles high standard of ingredients, they are bought from small suppliers. If there are shortages, these suppliers may be the first to deplete. Comparable Analysis Chipotle has many competitors, but few have experienced growth like Chipotle. In selecting companies for the comparable analysis portion of the valuation, we looked at growth estimates, size, product offering, risk to the market, and brand image. The multiples used were EV/EBIT and EV/EBITDA. We chose to weight only the bottom line multiples because they are a better indicator of the company s cash flows, and have a lesser chance of being influenced by our LTM numbers. Panera Bread Co. (PNRA) 40% Panera operates bakery-cafes in the United States and Canada. These cafes provide a variety of baked goods, sandwiches, soups, salads, and other complementary café products. The company was founded in 1981 in Saint Luis, Missouri and currently owns roughly 740 stores and franchises out an additional 801. Panera Bread CO. was given the highest weighting of the comparables at 40% because of its realized growth and its brand identity. Both Chipotle and Panera strive to deliver fresh ingredients and provide simple goods at a relatively fast rate. They are also located solely in the US & Canada and have yet to expand into Europe, although they plan to when they find a suitable menu. Starbucks Corp. (SBUX) 20% Starbucks purchases and roasts whole bean coffee in the United States, Canada, UK, China, Germany, and many other countries. Starbucks provides a variety of coffees and espressos as well as fresh food items including pastries, sandwiches, salads, and other items. Additionally, it sells branded bottled coffees and ice cream. Starbucks also owns several brands including Seattle s Best Coffee and Tazo tea. Starbucks Corporation was given a weighting of 20% because of its brand image and appeal to its target market. Starbucks offers a similar fresh ingredien t environment and values its employees highly. Though much larger than Chipotle, Starbucks realized significant growth over the last few years and has successfully expanded abroad. UOIG 9

10 Whole Foods Market, Inc. 25% Whole Foods Market owns and operates roughly 315 natural and organic supermarkets around the United States, Canada, and UK. They offer groceries, seaf ood, meat and poultry, produce, prepared foods, and supplements and vitamins. They also sell a variety of specialty products. Whole Foods Market, Inc. was chosen as a comparable because of its recent growth, size, and commitment to organic and sustainable foods. Whole Foods is not a direct competitor with Chipotle, however they share many of the same business strategies. Whole Foods was given a weighting of 25%. Jack in the Box, Inc. 0% Jack in the Box, Inc. owns Jack in the Box and Qdoba Mexican Grill restaurants across the United States. It owns and operates roughly 2,200 Jack in the Box s and 660 Qdoba restaurants. They acquired Qdoba in Jack in the Box, Inc. was looked at as a comparable mostly because of the Qdoba Mexican Grill branch. Qdoba is a pure play competitor to Chipotle, and they operate in an extremely similar manner. Over the pas t few years, Qdoba has significantly contributed to Jack in the Box s growth. Jack in the Box was not given a weighting because the majority owned fast-food chain dilutes the Qdoba fraction. The comparables analysis returns a large overvaluation. This is caused by Chipotle s extraordinary ability to expand with little pure competition. CMG has been able to consistently increase restaurants and exploit the fast casual boom. Additionally, there are few companies that have been able to replicate Chipotle s ability to retain customers in the fast casual market. The combination of rapid growth, consistent cash flows, and the proven ability to retain customers has given investors a reason to pay such a high price. Because there are few companies experiencing such growth, and none in the fast casual industry, we decided to weight comparables analysis 0% in our final valuation. Discounted Cash Flow Analysis In order to project future cash flows, we used management guidance, industry analysis, and our own assumptions. Most projections were based on a percent of sales. Revenue Model Projecting revenue required estimating future amounts for three different values: new restaurants, average revenue per comparable restaurant, and average revenue per new restaurant. The number of comparable restaurants was not projected because it is simply the addition of the previous year s number of comparable restaurants and the previous year s new restaurants. New Restaurants The number of new restaurants was projected based on management guidance and historical values and growth rates. For 2012, management stated they would add between 155 and 165 restaurants. From 2013 to 2014, we trended the number of new restaurants slightly upward as Chipotle takes advantage of the large number of A Model locations available. From 2015 until 2021, we trend down the number of new restaurants as the market becomes more saturated and less strong locations are available. UOIG 10

11 Average Comparable Restaurant Revenue For 2012, management expects average comparable restaurant revenue to experience a percent increase in the mid-single digits. CMG will experience this growth through customer loyalty (more repeat visits), increased advertising, and exemplary customer service. Since historical increases have been roughly in line with this mid-single digit growth, we simply trended down average comparable restaurant revenue growth into the year $10, $9, $8, $7, $6, $5, $4, $3, $2, $1, $0.00 Projected Revenue Growth Total Revenue EBITDA Margin 23.00% 22.00% 21.00% 20.00% 19.00% 18.00% 17.00% Average New Restaurant Revenue Average new restaurant revenue growth has been both higher and lower than average comparable restaurant revenue growth in recent years. However, as the Chipotle brand continues to gain strength, more talented Restaurateurs open new restaurants, and more A Model locations are opened, the average new store revenue is likely to grow slightly faster than already existing comparable restaurants. As a result, we project average new restaurant percent revenue growth to be slightly higher than average comparable restaurant revenue in 2012, and then trend it down into the year Cost of Goods Sold Model Chipotle s Restaurant operating costs include Food, beverage, and packaging, Labor, Occupancy Costs, and Other Operating Costs. Each expense was projected out separately and can be seen in Appendix 4. Certain key ingredients are subject to supply shortages, causing many of Chipotle s ingredients to incur a price increase. CMG s commitment to Food With Integrity sometimes creates limited source suppliers and thus, it will be difficult to avoid an increase in its Food, beverage, and packaging during times of certain commodity price increases. For example, Chipotle is expecting to see price hikes in beef, chicken, rice and beans while they are more optimistic about avocados, dairy, and produce. We project Food to increase slightly in the short term but eventually level out at a conservative rate of 32.85% of revenue. Labor and Other Operating Costs gain leverage by an increase in sales and therefore, are declining as a percentage of revenue going forward. Other Operating Costs were slightly higher than normal in 2011 due to an investment in marketing, and 2012 will be similar. However, over a longer period, we expect Other Operating Costs to be around 10.75% of revenue. Occupancy costs also benefit from an increase in sales as it is partially fixed, however as Chipotle leans toward more A-Model restaurant location, the ability to decrease this cost will become harder. General & Administrative Expense Management states that they are maintaining an effort to grow G&A at a slower rate than sales growth. However, the accounting charge of issuing noncash stock compensation has led to a slightly higher G&A expense in 2011 and will remain in Additionally, in 2012 CMG will host its biennial All Manger Conference, which will lead to an additional increase in G&A. Tax Rate CMG s tax rate has historically been in the high 38% range. Going forward, however, CMG expects its tax rate to be in the low 39% due to the expiration of certain legislation (HIRE Act) and tax credits. The tax rate is subject to change if Congress renews the Act or issues additional tax credits, but we projected CMG s tax rate at 39.3%. UOIG 11

12 Projected Capital Expenditures and Acquisitions $ $ $ $ $ $ Working Capital Current Assets and Current Liabilities were projected to remain roughly the in line as a percent of revenue going forward. Where applicable, certain accounting ratios were used to project line items. Days Sales Outstanding and Days Payable Outstanding trend slightly up and slightly down, respectively, as Chipotle matures as a company and is able to develop better relations with suppliers. Capital Expenditures Capital expenditures typically relate to new restaurants and continued reinvestments in existing restaurants. Recently, the majority of capital expenditures have been related to new restaurant construction. Management has stated that they expect between $150 million to $160 million in capital expenditures in We project capital expenditures staying around 6% of revenue, decreasing only slightly over time. $0.00 Capital Expenditures Beta Three different betas were calculated and weighted evenly for Chipotle Mexican Grill: 5 year monthly, 3 year monthly, and a 1 year weekly. The discrepancy between the 5 year monthly and 3 year monthly betas are due an extremely volatile period between 2007 and While these swings were unusual, we feel Chipotle is exposed to similar risk in its growth strategy. Beta SD Weighting 5 Year Monthly % 3 Year Monthly % 1 Year Weekly % Chipotle Mexican Grill, Inc. Beta 0.81 Intermediate Growth Rate Because of CMG s consistent growth and huge upside potential for international expansion, we decided that a terminal growth rate of 3% immediately after 2021 into perpetuity was not appropriate. In order to account for Chipotle s consistent performance and large international growth opportunities, we used an intermediate growth rate of 7% for the five years following 2021 until We then introduced the terminal growth rate of 3% in This required us to calculate a new terminal value and then discount it five additional years. Recommendation Although we believe CMG s strong brand image, focused business model, and deliberate growth strategies will result in consistent growth for the company, we feel that the market has already priced this in. This relatively fair valuation can be seen in our DCF result of 6.54% overvalued. Additionally, the high overvaluation that resulted from our relative analysis suggests that now may not be the best time to invest in CMG. As a result, we are recommending a HOLD for all portfolios. Final Valuation Implied Price Weighting Discounted Cash Flow Analysis % Comparable Anaylsis % Price Target $ Overvalued (6.54%) UOIG 12

13 Appendix 1 Comparables Analysis Comparables Analysis CMG PNRA SBUX WFM BWLD JACK ($ in millions) Chipotle Mexican Grill, Inc. Panera Bread Co. Starbucks Corporation Whole Foods Market, Inc. Buffalo Wild Wings Inc. Jack in the Box, Inc. Stock Characteristics Max Min Weight Avg. Median 40.00% 20.00% 25.00% 15.00% 0.00% Current Price $ $22.74 $ $84.07 $ $ $58.95 $84.42 $84.07 $ Day Moving Average Day Moving Average Beta Size Short-Term Debt Long-Term Debt Cash and Cash Equivalent 1, , Non-Controlling Interest Preferred Stock Diluted Basic Shares Market Capitalization 45, , , , , , , , , , Enterprise Value 44, , , , , , , , , , Profitability Margins Gross Margin 49.44% 11.79% 21.71% 27.01% 26.49% 23.04% 27.48% 11.79% 27.01% 49.44% EBIT Margin 17.94% 5.49% 11.30% 10.97% 17.94% 12.63% 15.60% 5.92% 10.97% 5.49% EBITDA Margin 21.13% 8.82% 15.60% 17.02% 21.13% 17.02% 19.95% 8.82% 17.34% 9.89% Net Margin 21.13% 8.82% 15.60% 17.02% 21.13% 17.02% 19.95% 8.82% 17.34% 9.89% Credit Metrics Interest Expense $34.00 $0.00 $8.10 $3.88 $3.23 $0.82 $34.00 $3.88 $0.00 $18.30 Debt/EV 33.26% 0.00%.70% 1.24% 0.00% 0.00% 1.24%.13% 2.81% 33.26% Leverage Ratio % 0.00% 9.92% 22.60% 0.00% 0.00% 22.60% 2.09% 32.53% % Interest Coverage Ratio % 37.60% % % % % 53.62% % NA 37.60% Operating Results Revenue $12, $ $5, $2, $2, $1, $12, $10, $ $2, Gross Profit 3, , , , , , EBIT 1, , EBITDA 2, , Net Income 1, , Valuation EV/Revenue 5.48x 0.68x 2.35x 2.01x 5.48x 2.41x 3.64x 1.44x 2.01x 0.68x EV/Gross Profit 20.70x 1.30x 11.08x 10.46x 20.70x 10.46x 14.03x 11.88x 7.44x 1.30x EV/EBIT 30.57x 12.41x 21.12x 19.09x 30.57x 19.09x 23.32x 24.29x 18.30x 12.41x EV/EBITDA 25.96x 6.88x 15.13x 14.17x 25.96x 14.17x 18.23x 16.31x 11.59x 6.88x EV/Net Income 56.94x 24.68x 34.67x 32.31x 56.94x 32.31x 34.60x 40.56x 31.25x 24.68x Multiple Implied Price Weight EV/Revenue % EV/Gross Profit % EV/EBIT % EV/EBITDA % EV/Net Income % Price Target $ Current Price Overvalued (35.35%) UOIG 13

14 Appendix 2 Discounted Cash Flows Analysis Discounted Cash Flow Analysis ($ in millions) 2008A 2009A 2010A 2011A Q1 2012A Q E 2012 A+E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E Total Revenue % YoY Growth 13.99% 20.91% 23.62% 19.90% 18.52% 17.40% 16.11% 14.80% 13.53% 12.42% 11.44% 10.57% 9.77% Cost of Goods Sold % Revenue 78.46% 75.07% 73.34% 74.04% 72.63% 74.81% 74.30% 74.00% 73.50% 73.20% 72.80% 72.65% 72.40% 72.35% 72.05% 71.90% Gross Profit $ $ $ $ $ $ $ $ $1, $1, $1, $1, $1, $1, $2, $2, Gross Margin 21.54% 24.93% 26.66% 25.96% 27.37% 25.19% 25.70% 26.00% 26.50% 26.80% 27.20% 27.35% 27.60% 27.65% 27.95% 28.10% General and Administrative Expense % Revenue 6.69% 6.53% 6.46% 6.58% 7.70% 6.33% 6.65% 6.50% 6.40% 6.30% 6.20% 6.10% 6.00% 5.90% 5.80% 5.70% Depreciation and Amortization % Revenue 3.96% 4.04% 3.75% 3.30% 3.14% 4.81% 4.42% 4.49% 4.59% 4.71% 4.85% 5.03% 3.77% 4.06% 4.16% 4.25% Pre-opening Costs % Revenue 0.87% 0.39% 0.34% 0.26% 0.38% 0.27% 0.30% 0.35% 0.40% 0.40% 0.35% 0.30% 0.25% 0.20% 0.20% 0.20% Loss on Disposal of Assets % Revenue.70%.39%.34%.26%.20% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Earnings Before Interest & Taxes $ $ $ $ $ $ $ $ $ $ $ $ $1, $1, $1, $1, % Revenue 9.31% 13.41% 15.68% 15.44% 15.96% 13.78% 14.29% 14.66% 15.11% 15.39% 15.80% 15.92% 17.58% 17.49% 17.79% 17.95% Interest Expense % Revenue.02%.03%.01%.13% 0.00%.13%.10%.09%.08% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Net Interest (Income) (3.47) (0.93) (1.50) (2.95) (0.43) (2.29) (2.72) (2.58) (2.27) % Revenue (.26%) (.06%) (.08%) (.13%) (.07%) (.11%) (.10%) (.08%) (.06%) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Earnings Before Taxes , , , , % Revenue 9.55% 13.45% 15.74% 15.44% 16.03% 13.75% 14.29% 14.65% 15.09% 15.39% 15.80% 15.92% 17.58% 17.49% 17.79% 17.95% Less Taxes (Benefits) Tax Rate 38.51% 37.90% 38.09% 38.45% 38.96% 39.42% 39.30% 39.30% 39.30% 39.30% 39.30% 39.30% 39.30% 39.30% 39.30% 39.30% Net Income $78.24 $ $ $ $62.66 $ $ $ $ $ $ $ $ $ $ $ Net Margin 5.87% 8.35% 9.75% 9.51% 9.78% 8.67% 8.89% 9.16% 9.34% 9.59% 9.66% 10.67% 10.62% 10.80% 10.89% Add Back: Depreciation and Amortization Add Back: Interest Expense*(1-Tax Rate) Operating Cash Flow $ $ $ $ $82.75 $ $ $ $ $ $ $ $ $1, $1, $1, % Revenue 9.85% 12.40% 13.51% 12.89% 12.92% 13.22% 13.15% 13.44% 13.80% 14.05% 14.44% 14.69% 14.44% 14.68% 14.96% 15.15% Current Assets % Revenue 9.04% 4.92% 9.64% 4.13% 27.26% 8.83% 6.75% 6.78% 6.80% 6.83% 6.82% 6.82% 6.82% 6.81% 6.81% 6.81% Current Liabilities % Revenue 5.82% 6.78% 6.70% 6.94% 19.44% 8.65% 6.62% 6.59% 6.54% 6.50% 6.48% 6.47% 6.45% 6.42% 6.42% 6.40% Net Working Capital $42.95 ($28.26) $54.01 ($63.74) $50.09 $3.75 $3.75 $6.10 $9.54 $14.43 $17.27 $20.22 $23.86 $27.85 $31.36 $35.35 % Revenue 3.22% (1.86%) 2.94% (2.81%).14%.19%.25%.33%.34%.35%.37%.39%.40%.41% Change in Working Capital Capital Expenditures % Revenue 11.42% 7.72% 6.17% 6.66% 6.54% 6.03% 6.15% 6.10% 6.10% 6.05% 6.05% 6.05% 6.00% 6.00% 6.00% 6.00% Unlevered Free Cash Flow ($20.91) $ $52.57 $ ($72.95) $ $ $ $ $ $ $ $ $ $ $ Discounted Free Cash Flow EBITDA EBITDA Margin 13.28% 17.45% 19.43% 18.75% 19.09% 18.58% 18.70% 19.15% 19.70% 20.10% 20.65% 20.95% 21.35% 21.55% 21.95% 22.20% UOIG 14

15 Appendix 3 Revenue Model Revenue Model ($ in millions) 2008A 2009A 2010A 2011A Q1 2012A Q E 2012A+E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E Comparable Restaurants $1, $1, $1, $2, $ $1, $2, $2, $3, $4, $4, $5, $6, $6, $7, $8, % Growth 18.00% 22.15% 22.59% 20.28% 19.56% 18.30% 17.14% 15.90% 14.41% 13.16% 12.06% 11.10% 10.24% New Restaurants $ $ $ $ $13.88 $ $ $ $ $ $ $ $ $ $ $ % Growth 9.03% (11.30%) 10.52% 33.13% 16.71% 9.31% 8.70% 5.25% 2.06% 1.82% 1.48% 1.13%.77%.41% Total Revenue $1, $1, $1, $2, $ $2, $2, $3, $3, $4, $5, $5, $6, $7, $7, $8, % Growth 13.99% 20.91% 23.62% 19.90% 18.52% 17.40% 16.11% 14.80% 13.53% 12.42% 11.44% 10.57% 9.77% Comparable Restaurants Average Revenue $1.633 $1.617 $1.733 $1.874 $0.510 $1.522 $1.987 $2.102 $2.223 $2.347 $2.476 $2.606 $2.737 $2.867 $2.996 $3.123 % Growth -0.99% 7.20% 8.12% 6.00% 5.80% 5.75% 5.60% 5.50% 5.25% 5.00% 4.75% 4.50% 4.25% New Restaurants Average Revenue $1.371 $1.359 $1.396 $1.629 $0.43 $1.302 $1.735 $1.839 $1.941 $2.043 $2.148 $2.255 $2.362 $2.469 $2.573 $2.676 % Growth -0.87% 2.75% 16.71% 6.50% 6.00% 5.50% 5.25% 5.15% 5.00% 4.75% 4.50% 4.25% 4.00% Total Restaurants Appendix 4 Cost of Goods Sold Model COGS Model ($ in millions) 2008A 2009A 2010A 2011A Q1 2012A Q E 2012A+E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E Food, Beverage, & Packagin $ $ $ $ $ $ $ $1, $1, $1, $1, $1, $2, $2, $2, $2, % Revenue 32.43% 30.69% 30.56% 32.55% 32.25% 33.49% 33.20% 33.30% 33.20% 33.20% 33.10% 33.10% 33.00% 33.00% 32.85% 32.85% Labor $ $ $ $ $ $ $ $ $ $1, $1, $1, $1, $1, $1, $1, % Revenue 26.35% 25.36% 24.71% 23.93% 23.73% 23.82% 23.80% 23.65% 23.50% 23.35% 23.20% 23.05% 22.90% 22.85% 22.70% 22.55% Occupancy Costs $98.07 $ $ $ $40.51 $ $ $ $ $ $ $ $ $ $ $ % Revenue 7.36% 7.52% 7.02% 6.49% 6.32% 6.23% 6.25% 6.00% 5.75% 5.75% 5.75% 5.75% 5.75% 5.75% 5.75% 5.75% Other Operating Costs $ $ $ $ $66.18 $ $ $ $ $ $ $ $ $ $ $ % Revenue 12.31% 11.50% 11.05% 11.07% 10.33% 11.27% 11.05% 11.05% 11.05% 10.90% 10.75% 10.75% 10.75% 10.75% 10.75% 10.75% Total COGS $1, $1, $1, $1, $ $1, $2, $2, $2, $3, $3, $4, $4, $5, $5, $6, % Revenue 78.46% 75.07% 73.34% 74.04% 72.63% 74.81% 74.30% 74.00% 73.50% 73.20% 72.80% 72.65% 72.40% 72.35% 72.05% 71.90% UOIG 15

16 Appendix 5 Working Capital Model Working Capital Model ($ in millions) 2008A 2009A 2010A 2011A Q1 2012A 2012 A+E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E Total Revenue $1, $1, $1, $2, $ $2, $3, $3, $4, $5, $5, $6, $7, $7, $8, Current Assets Accounts Receivable Days Sales Outstanding A/R % of Revenue 0.27% 0.31% 0.31% 0.37% 1.42% 0.38% 0.41% 0.44% 0.48% 0.48% 0.48% 0.48% 0.48% 0.48% 0.48% Inventory Days Inventory Outstanding NA % of Revenue 0.36% 0.37% 0.39% 0.39% 1.56% 0.40% 0.41% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.39% 0.39% Prepaid Expenses Days Prepaid Expense Outstanding NA % of Revenue 0.88% 0.95% 0.87% 0.94% 4.08% 0.97% 0.96% 0.96% 0.95% 0.95% 0.95% 0.94% 0.94% 0.94% 0.94% Income Tax Receivable $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 % of Revenue 0.02% 0.00% 1.28% 0.00% 5.45% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Investments $ $ $ $ $ $ $ $ $ $ % of Revenue 7.51% 3.29% 6.80% 2.42% 14.75% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% Total Current Assets % of Revenue 9.04% 4.92% 9.64% 4.13% 27.26% 6.75% 6.78% 6.80% 6.83% 6.82% 6.82% 6.82% 6.81% 6.81% 6.81% Long Term Assets Net PP&E Beginning Capital Expenditures Depreciation and Amortization Net PP&E Ending Total Current Assets & Net PP&E % of Revenue 53.03% 46.84% 46.51% 37.26% % 36.12% 33.17% 30.79% 28.84% 27.19% 25.78% 25.91% 25.89% 25.91% 25.95% Current Liabilities Accounts Payable Days Payable Outstanding % of Revenue 1.79% 1.66% 1.84% 2.04% 7.67% 1.93% 1.93% 1.91% 1.90% 1.89% 1.89% 1.88% 1.88% 1.88% 1.87% Accrued Charges Days Charges Outstanding % of Revenue 3.97% 4.78% 4.86% 4.70% 11.75% 4.68% 4.66% 4.63% 4.60% 4.59% 4.58% 4.56% 4.55% 4.54% 4.53% Total Current Liabilities % of Revenue 5.82% 6.78% 6.70% 6.94% 19.44% 6.62% 6.59% 6.54% 6.50% 6.48% 6.47% 6.45% 6.42% 6.42% 6.40% Appendix 6 Discounted Cash Flow Assumptions & Considerations Discounted Free Cash Flow Assumptions Tax Rate 39.30% Terminal Growth Rate 3.00% Risk Free Rate 2.00% Terminal Value 24,462 Beta 0.81 PV of Terminal Value 8,059 Market Risk Premium 7.00% Sum of PV Free Cash Flows 4,597 % Equity % Firm Value 12,656 % Debt 0.00% Total Debt 0 Cost of Debt 0.00% Cash & Cash Equivalents 370 CAPM 7.68% Market Capitalization 12,656 WACC 7.68% Fully Diluted Shares Implied Price Current Price Overvalued (6.54%) Considerations Avg. Industry Debt / Equity 10.67% Avg. Industry Tax Rate NA Current Reinvestment Rate 47.90% Reinvestment Rate in Perpetuity 16.45% Implied Return on Capital in Perpetuity 18.24% Terminal Value as a % of Total 63.7% Implied 2013E EBITDA Multiple 20.5x Implied Terminal Year Multiple 4.2x Terminal Free Cash Flow Growth Rate 12% 5 Year Intermediate Growth Rate 7% UOIG 16