Since going public in early 2006, shares of restaurant chain Chipotle Mexican Grill(NYSE: CMG) are up more than 4,700%, turning a $10,000 investment into nearly half a million dollars. Underpinning these magnificent returns has been the company's impressive growth. At the end of 2005 it had 481 locations whereas today it has over 3,200.
The expansion of the chain drove market-crushing returns for Chipotle stock. But investors are rightly concerned about how much bigger this chain can get. And if it can't keep expanding, then maybe its days of good returns are coming to an end.
Chipotle shareholders just received pertinent news on this topic. The company has signed a development agreement in the Middle East, kicking management's international-expansion plans into high gear. Here's what it means for investors.
Uncharted territory for Chipotle
Of Chipotle's 3,200 locations, the majority are located in the U.S. After this, Canada and the U.K. are the two largest international markets. And it has a very small presence in Germany and France.
These Chipotle locations all share a common trait: They're company-owned.
On July 18, Chipotle announced a partnership with Kuwaiti company Alshaya Group to develop restaurant locations in the Middle East, starting with the United Arab Emirates and Kuwait. For Chipotle, it's uncharted territory geographically. But it's also uncharted territory with the business model because these will be franchised locations.
For restaurant stocks, there's a big difference between the company-owned operating model and the franchised model. For illustrative purposes, consider Yum! Brands. Its portfolio includes KFC, Taco Bell, Pizza Hut, and the Habit Burger Grill. And with over 55,000 locations, it's the largest restaurant company in the world by locations -- about 17 times larger than Chipotle.
However, Yum! Brands franchises 98% of its restaurants. Rather than collect revenue directly from sales, it generates revenue from franchise fees, which are logically much smaller than overall sales. For this reason, Chipotle's revenue is actually higher than that of Yum! Brands despite having far fewer locations.
Alshaya Group plans to open its first Chipotle locations early in 2024.
What it means for investors
First, investors should temper expectations with this announcement. Chipotle locations won't start opening until next year. And there will likely be a learning curve, both for Alshaya and Chipotle, before expansion in the Middle East really accelerates. In short, investors shouldn't expect much from this now.
The bigger immediate opportunity for Chipotle shareholders, therefore, is its ongoing U.S. expansion. In 2023 alone, the company could open up to 285 new locations. And management plans to grow by 8% to 10% annually thereafter until reaching its long-term goal of 7,000 locations in North America.
In other words, don't discount Chipotle's business in North America. It believes it can more than double the size of the company on this alone. And because these are company-owned locations with enviable profit margins, the company potentially has a lot of profit growth ahead.
That said, the advantage of the franchise model is that it will allow Chipotle to experiment with expansion in the Middle East at little cost. If it's not successful, the company hasn't wasted much. If it is successful, it won't see much in terms of revenue growth necessarily. But as the example with Yum! Brands shows, it could still be consequential to Chipotle's bottom line, due to superior margins.
Moreover, Chipotle's partnership with Alshaya Group may be its only franchise agreement at the moment but it doesn't appear as though it will be the last. In conjunction with its announcement for expansion in the Middle East, Chipotle also launched a new business development group division that will explore future franchise agreements, likely in other international markets.
Will the stock skyrocket?
To me, Chipotle's franchise agreement with Alshaya isn't something that will cause the stock to skyrocket. Skyrocketing implies a quick upward movement over a short time period. And the development agreement will progress slowly.
However, stock prices tend to go up over the long term with profit growth. Chipotle has opportunities both domestically and abroad to grow its bottom line. And it's possible that its agreement with Alshaya is simply the first of many deals to ramp up new restaurant openings internationally. Therefore, this is something that can support market-beating returns in the future.
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