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When quick-service restaurant groups get things right, they really get it right. Fast-growing companies in this sector can achieve rapid expansion because of the franchise model and the oldest trick in the book: using other people’s money.

Chipotle Mexican Grill and Wingstop are excellent examples of not just what success looks like in this space, but what investors are willing to pay for that success.

Episode 175 of Magic Markets is brought to you by Future Forex. Listen to Episode 170 for a detailed discussion with co-founder and CEO Harry Scherzer on why South Africans shouldn’t allow their annual offshore investment allowances to go to waste, with crypto arbitrage offering an interesting boost to returns. In Episode 173, you can learn about how Future Forex is disrupting the mainstream banks by making international money transfers simpler and more affordable for forex clients.

Future Forex SA (Pty) Ltd is a registered financial services provider, FSP number 51884.

Full transcript:

The Finance Ghost: Welcome to episode 175 of Magic Markets. And if you are hungry, look away now, go and eat something and then come back. Because today, Moe, we are talking about food and yummy food. Not salads, but chicken wings and Mexican and all those delightful things. So that’s our warning out the way. If you’re listening to this on an empty stomach, we apologise and we suggest you possibly come back after lunch or dinner.

Mohammed Nalla: I love that as an intro, Ghost. I mean, yes, absolutely. This week we’re covering some very interesting stocks. Some that you might have heard of, some that you may not have heard of. So, Ghost, I’m going to be looking at a brand that has really been very popular here in North America. And if you look at the share price, you can just see how popular that brand’s actually been. I think you’ve got a similar story with yours as well. But I’m covering Chipotle Mexican Grill, and I know that’s not a brand you get in South Africa, but quintessential Mexican food, you’re looking at burritos, burrito bowls, quesadillas, tacos are very popular, as you’d expect, up here in North America. And interestingly enough, even in Canada, Chipotle starting to actually build out their footprint. We’ll get into some of that. What are you covering, Ghost?

The Finance Ghost: Yeah, so just on that, it’s frustrating for me in South Africa that no one has really done Mexican at scale. We’ve got a few franchises, but there’s no scale Mexican play. If you go to your local food court, there’s no guarantee you’re going to get a high quality taco option or whatever the case may be. And I really enjoy Mexican food, so I long for this day. But what I am doing is a food category that is very successful in South Africa, and that is chicken. And in this case, the company I’m covering is not Yum! Brands with KFC, but rather something called Wingstop, which I saw on FinTwit in the past couple of weeks. I’d never heard of it. I mean, we don’t get them in South Africa. I don’t even think you’ve seen one before. But the share price has gone absolutely ballistic. So if it’s cool with you, I’ll just jump straight in.

Because the one thing they talk about in their product set is something called chicken tenders. Now, the chicken tendies, Moe, you’ll remember from the meme stock chaos. And of course, what has happened on Twitter in literally the last couple of days? Roaring Kitty posts a meme and the GameStop share price goes bananas and AMC goes nuts. And it’s all chicken tendies and diamond hands, right?

Mohammed Nalla: Yeah, Ghost, I just actually want to say that I think the secret here is putting “stop” after your company name, right? Because we’ve got GameStop, now we’ve got Wingstop, and so we should call this Magic Markets Stop and then have a share price that maybe just goes to the moon. I think it’s so phenomenal that we’re covering Wingstop at a time when GameStop’s actually just going bananas because Roaring Kitty’s back, right?

The Finance Ghost: Yeah, it is fantastic. And Wingstop has a great ticker, which is $WING if you want to go and check it out. And they talk about being in the flavour business, and they’ve been doing it since 1994, with the first franchise opening in 1997. Now, where else would a good chicken wings business be headquartered but in good old Texas? In this case, Dallas.

And as a completely ridiculous statistic, they had served a billion wings by 2002. A billion! That is a lot of chicken. I shudder to think what that stat must be by now. I mean, that was 22 years ago, and they now have over 2,200 global locations. So it seems like whilst we all have our differences in this world, a love of chicken appears to be universal. And as you would hope to see in a quick service restaurants brand taking the world by storm, there is massive growth in their footprint. They are already operating in eleven global markets, and they opened 255 new restaurants in 2023.

For the three years to 2023, you’re looking at a CAGR (compound annual growth rate), of 27% a year in adjusted EBITDA. They achieved average cash conversion of 76.5%, which basically tells you that they spend roughly a quarter of their EBITDA on capex, or reinvested on capex, rather. And they’re really not slowing down because the first quarter of 2024 has shown 21.6% same-store growth in their domestic footprint.

So if that hasn’t gotten your attention yet, here’s something that will. The share price is up 83% in the past twelve months, or 375% in the past five years. When QSR models work, they really work. Never mind cloud computing and Cathie Wood and ARK and AI and all that stuff. Chicken wings. Chicken wings, Moe. That’s where it’s at.

Mohammed Nalla: The secret’s all in the chicken wings. I’m actually curious. I just wonder when some of these brands will find their way into South Africa, because, again, chicken, very popular down there. But going back to Chipotle Mexican Grill, I mean, you’re right, you don’t have many great Mexican options down in South Africa. I mean, the closest thing you might get to that would be Muchachos. Great flavour. You know, that’s a flavour I ironically actually miss the most living out here. There’s nothing like that. So when I come back to South Africa, the first thing I go and grab is I go and grab a Muchachos burger. But your first point almost wants me to jump into my second point, because I’m going to look at what does that run rate look like on the share price, how many stores have they actually rolled out.

But before we do that, as my first point, I want to just start off with what Chipotle is and then how they go about doing their business. And again, like I say, it’s effectively your quick service restaurant. We’ve covered that. They cover Mexican food specifically, and like I said, burritos, quesadillas, tacos, lots of salads. So again, that might also talk to the popularity of Chipotle over some of the other, let’s call it McDonald’s, you go and get a burger. Well, guess what? Salads are a lot more palatable given the health climate we’re in right now.

Now, the important point I want to land on here is Chipotle’s business strategy, we always look at this when we look at stocks in detail in Magic Markets Premium. So I thought, let me look at it for this particular show, because sometimes you get a lot of corporate gumph. And I said, well, do we get the same thing at Chipotle? And interestingly enough, they rest their business on what they call five pillars, and they’re actually quite simple if you look at it.

So the first one is just running successful restaurants. Sounds simple. Yes, we know there are lots of complexities to that, but that is central to what they aim to do. The second one is attracting and retaining diverse talent. Now, that’s important because we know the kind of pressures that some of these businesses, if you look at Starbucks, lots of union pressures coming through. So you’d expect that to be one of the core pillars of this business then. And what I would say, very importantly, making the brand visible, relevant and loved. And I would argue they’ve done that quite successfully in the United States. Like I say, they’re now expanding quite aggressively in Canada. And there’s a bit of a question mark around that one. Again, the Chipotle that’s opened up near me has gotten a bunch of bad reviews. So, not quite loved yet.

Then the fourth point, investing heavily in restaurant tech and innovation. And I want to really resonate on this point, because you’re going to see just how important that is to Chipotle’s story in my next couple of points. And then the last one, improving access and convenience for customers. And I will almost bucket point four and point five together, because the innovation, the restaurant tech, is really aimed at improving access and convenience. So if we actually say this shows us a business that’s very firmly focused on its brand and delivering operationally well on taking that brand, taking their food into consumers’ bellies, let’s call it that, right.

“Just over the last five years, they’ve signed up over 40 million members on their digital channels alone. Their online sales now average $1.1 million per store in 2023. And if you take that stat alone, just its online, just it’s digital, would make their digital segment amongst the top 50 restaurants in the United States based on volume.”

Now, they’ve actually carved out this very strong niche. What does that look like? Just over the last five years, they’ve signed up over 40 million members on their digital channels alone. Their online sales now average $1.1 million per store in 2023. And if you take that stat alone, just its online, just it’s digital, would make their digital segment amongst the top 50 restaurants in the United States based on volume. So that’s showing you why I wanted to emphasise that tech and innovation point quite strongly. Because it’s about doing digital right, because that helps them increase frequency of purchases, it helps with lower churn, it gets customers coming back. And interestingly enough, they’re not just doing this via their online platform, they’re also doing it on their footprint. They’ve got smaller digital-only concepts called Chipotlanes. You know, that’s effectively just allowing you to pre-order. You drive through, you pick up your food and you move on. And that now makes up 25% of their group footprint. So showing you how important that real putting the quick in quick service restaurants, putting digital into that has become for this business. In aggregate, digital making up 30% to 40% of the group’s total volumes.

And I want to land on one last point before I hand back over to you, Ghost. This is very interesting in that it reminds me of the way Capitec disrupted South African banks. You had a whole bunch of very large incumbents, big footprints, doing business the old way. And then Capitec came in and they said, we’re going to focus on tech, we’re going to focus on smaller, more efficient branches. This is effectively doing the same thing, but it’s doing it in the QSR segment and doing it very successfully if you have a look at that share price.

The Finance Ghost: Yeah, digital’s a bit of a sore point for me because I had a pretty disastrous Nando’s order today. But if digital can be done right, then it obviously makes a huge difference. Today I was quite “hangry” around lunchtime as I waited for the scooter to arrive. Anyway, over at Wingstop, digital sales there, 68.3% of system-wide sales. So there’s a nice comparative for you there, Moe. The business has done a pretty good job as well of just landing into that delivery culture with consumers.

“Let’s dig into some more of their statistics, which really are rather interesting. So you’ll recall I mentioned same-store sales growth of 21.6%. Now we’ve just covered Coca-Cola in Magic Markets Premium and there it’s not about volumes growth, it’s all about pricing. It is the complete opposite at Wingstop, their same-store sales growth almost entirely thanks to volumes rather than pricing.

Let’s dig into some more of their statistics, which really are rather interesting. So you’ll recall I mentioned same-store sales growth of 21.6%. Now we’ve just covered Coca-Cola in Magic Markets Premium and there it’s not about volumes growth, it’s all about pricing. It is the complete opposite at Wingstop, their same-store sales growth almost entirely thanks to volumes rather than pricing. So super high-growth business right now, they don’t need to take price because their throughput is just getting better and better and they’re driving those volumes and that is a very nice place to be. And of course, this is why restaurants are being opened at such pace. There’s a lot of appeal here for franchisees. There are 1924 franchised restaurants in the footprint and only 50 are company-owned on top of that, so very much a franchise-heavy approach. And there’s a further 305 franchise restaurants abroad, with the international expansion typically achieved through master franchise agreements.

I mean, this is something we’ve seen before, very, very mixed results in South Africa, funnily enough, with these master franchise agreements bringing international brands in here. I don’t really think Starbucks has worked out. Domino’s was a complete disaster, so very hit and miss there. But of course, because the footprint is growing through franchised stores and thus other people’s capital and it takes $500,000, by the way, to open a store, Wingstop can actually go and pay a dividend despite being such a fast-growing company. And that is not something you will see every day.

So when you combine a little bit of yield and all of the discipline that takes, along with upgraded earnings guidance from mid single digit to low double digit same-store sales growth, you get a recipe that investors love. Particularly at a time when other major QSR players are generally reporting pressure on sales and difficulties in dealing with consumer pressures. Even in the US, McDonald’s and the like are having to release more and more value meals. And yet here we have Wingstop busy selling basically premium chicken wings. And that sounds ridiculous, but in the junk food culture of the US, just healthy food is premium stuff. It’s very hard for South Africans to truly understand and trends like people wanting real healthy food really help here. There’s no debate about what is in a chicken wing. As for a McChicken, that’s a different conversation.

Mohammed Nalla: I find some of those data points so interesting because you mentioned $500,000 to set up a store, that’s actually on the lower end here in North America. I mean, if you look at a normal format of, let’s call it even a Krispy Kreme, for example, you know, we’re talking healthy food, let’s talk donuts, right? It’s at the American way. That’s going to set you back, I would estimate, around two and a half to $3 million. So again, that smaller footprint that you’re seeing come through on the likes of a Wingstop or for example, Chipotle as well, is really quite important to how quickly they can roll out that footprint.

Now, I’m going to move from your point into what I would say some of the numbers on Chipotle Mexican Grill actually look like. Now, I mentioned that it’s been very successful and the share price has just gone over $3,200 a share. Yes, you heard that correctly. $3,200 for one share of Chipotle Mexican Grill. Now, this obviously raises a lot of questions around how accessible is this. I mean, some time ago we had Amazon trading up at those kind of levels, and then we go through stock splits just to make that stock a lot more accessible to a broader investor base. And that’s currently a discussion that is happening at Chipotle. They’re considering a 50-to-one stock split. Now, normally you get twenties, I’ve even seen 30-to-one. But a 50-to-one stock split, that’s quite rare. But it might actually bring that share price down to around the $60 region, which certainly will make it a lot more accessible. 

Now, why is this important? We just mentioned how GameStop’s actually gone bananas. Meme stock’s accessibility to retail investors is obviously a very important point. Yes, it might introduce volatility into the share price, but this is something that the board has approved at Chipotle. They’ve said yes, there are a-go for actually a 50-to-one stock split. It’s going to go to a shareholder vote in June and we’ll see where that lands. Now, if we look at some of the other statistics, interestingly enough, we’ve got a very large activist shareholder called Bill Ackman. And you’ll remember him from his fights with Disney. Well, Bill Ackman is a large shareholder at Chipotle Mexican Grill.

How large, you say? Well, he owns around 3% of the firm. Certainly gets him into the top ten. I think he’s number seven. But wait for it, it makes up 13% of his Pershing Square Capital portfolio. So that is a really big bet. And certainly if you look at the share price performance, I would argue it’s paid off because he got in some time ago. What does that look like over the longer term? You mentioned how Wingstop’s actually up around 80% over the last twelve months. So I’m feeling a little bit down here, Ghost, because it’s only been around 56%. Yes, 56% at Chipotle Mexican Grill. Shock and horror. But over the longer term, let’s look at that over five years. It’s a compound annual growth rate of 35% per year over the last five years. That’s pretty high. If we look at it over ten years, it’s got a ten year run rate of 19%. So, consistent double digit returns over the long term is why we find ourselves in the territory where the stock has to consider a 50-to-one split.

One last point I want to land on, and this becomes a lot more operational rather than the share price performance. You mentioned some of the data around store rollout. Well, Chipotle looking at adding around 300 stores this year. And again, that might not seem like a big number, but they’re currently sitting on around three and a half thousand stores. They’re going to look at rolling out, roughly call it 10% of that base, over the course of the next year. But their longer term, and read this as a ten year target, is to have around 7000 stores in the US. This is not global – in the US, and certainly looks as though they’re on track to achieve that. This is a group with no debt on the balance sheet, really strong, and the ability to roll that out is arguably still well on track.

The Finance Ghost: Look, when these QSR businesses work, they really, really work. And Wingstop, perfect example of this. So the question here is, can the growth continue? And I think that the information they give on their customers suggests that it probably can. They have higher income customers generally, which again, goes to the whole healthy food point. Again, it is absurd that just because it’s like, you know, actual real identifiable meat, it’s healthy, but anyway. And a lot of their customers are Gen Zs or Millennials, and they are less likely to have kids at home, which is obviously why they have disposable income for chicken wings. Anyone who has had kids will know your disposable income disappears the day they arrive. And of course, those customers prefer to engage with a brand digitally, because what could be more fun while you’re sitting at home with no responsibilities in this world than to order yourself some chicken wings to arrive on a scooter? 

Now, it’s pretty difficult to beat that in terms of the right demographic to grow into. And for what it’s worth, you know, because life is tough for Gen Zs, they also tend to prefer boneless products. No one has time for bones in their chicken. And Wingstop loves that from a margin perspective, because, you know, chicken wings come with bones naturally. We haven’t yet invented boneless chickens, and so that’s going to cost you money if you don’t want to deal with that. Now, aside from the demographic trends that look to be favourable, and all the cheekiness I’ve dished out around that, there are consumer spending habits that just work well for something like this. We can see it playing through. And of course, Wingstop can also achieve efficiencies through better throughput and speed of service to address these demographic trends. They have to manage it carefully, because the last thing they want to do is turn into another McDonald’s. It still needs to look healthy, it still needs to taste good, it still needs to be freshly made. 

And of course, with all this excitement, you’ve probably guessed by now that the valuation is through the roof. Five year average price to sales 15.7x. Wingstop currently at 23x. So they are way above even their five year average. But now, brace yourself for the price earnings multiple at a spectacular 139 times on a forward basis, Moe. TIKR tells me that it’s 106 times. So, you know, still pretty crazy. But at the peak of the 2021 madness, the trailing earnings multiple was nearly 200x. 

Now, before you wonder how on earth it is possible that anyone can wait 200 years to be paid back on the chicken wings. The multiple is all about the growth expectations, not the current level of earnings. If earnings double, that multiple unwinds to 100x if the share price doesn’t move. If earnings double again after that, it’s down to 50x. Now, if is a big word here, of course, but earnings per share is up 4x from 2019 to 2023. So these growth stories do exist. I do think that a multiple like that requires a lot of detailed work before you even contemplate putting on a long position.

That does seem like a vast amount of money to pay for chicken wings, but it’s still one to put on the radar here. And I’m happy to have covered it this week. And I’m glad I saw it on FinTwit because it’s really not a name that is known to the South African audience. And with a share price compound annual growth rate over the last nine years of 33%, it does show you that even at high multiples, the right growth story can still give you absolutely delicious returns. You just have to be very careful of that multiple unwinding with you still in the share. 

Mohammed Nalla: Yeah I’m going to shorten the show just by saying ditto, right? Because I could take your entire third segment, replicate a lot of that for Chipotle. Yes okay, maybe, you know, Wingstop’s run rate’s been a lot faster, certainly more recently. One note of caution: if you look in those compound annual growth rates, it is obviously highly sensitive to these stocks having gone parabolic over the course of the last twelve months and so forth. So you’ve accrued a lot of that return over a very short period of time, and that certainly tends to flatter what the long term performance looks like. 

But when I say ditto, I mean your point around higher income demographics, that’s very much the same playbook here at Chipotle Mexican Grill. Your points around digital fulfilment and ordering online, that’s the same story. We’ve touched on that. And similarly, if we have a look at those multiples, let’s look at valuation. It’s a similar, not exactly the same extent of craziness as Wingstop. And that’s because this is not Chipotle Stop. But let’s look at some of those multiples. You looked at it relative to some of the other QSRs. Currently, Chipotle Mexican Grill on a price/sales ratio of 7.5 times. I’m going to use another comparative here. I’m going to compare this to Alphabet or Google. That’s a stock that we covered recently on magic markets premium. And Google trades at a price/sales multiple of five times.

So if you’re looking at Chipotle Mexican Grill, that’s trading at a premium to some of the big tech players that have also been out there delivering really solid growth that’s come through. This just showing you the extent of optimism and growth that is priced into some of these QSR high-growth plays. We can obviously compare to the likes of Nvidia. That’s a 20x. But again, that’s maybe not the right comparative. That’s really on the outlier side of things. Let’s compare it to McDonald’s. We haven’t really touched on McDonald’s. Slightly cheaper than Chipotle at around seven times, but just showing you the premium that the newer brand Chipotle, with their digital, with their new initiatives in terms of fulfilment actually earns. And then Yum! Brands down at around five times. So a little less exciting, but still pretty heady multiples when you’re looking at these price to sale multiples.

You touched on a PE ratio. So I’m going to look at trailing twelve months. That’s currently sitting at 68 times at Chipotle. So still very much in high-growth territory. Because like you say, as the growth gets delivered, yes, the earnings multiple will unwind. But your point around needing to do a lot of homework before you consider position there, certainly quite key. A last point here is that this is not a stock that pays dividends. Again, no surprises. With a high-growth business, they don’t tend to pay dividends. They tend to keep that capital and use that capital to actually fuel and deliver the growth that the market is expecting.

Wrapping this all up – not in a wrap, not in a tortilla, not in a quesadilla – wrapping this all up, I think really exciting food. It’s a great operation, but there’s a lot of optimism priced in. When a stock starts looking at a 50-to-one split, that’s telling you that it’s run really hard. Will they get some of the uplift? Well, I certainly think yes, a lower share price will obviously introduce a lot more investors, certainly more retail investors. That for me is another risk or a caution flag. But again, what do I know? You know, I’m not Roaring Kitty, I’m not there saying go and YOLO yourself into GameStop but Chipotle, certainly one for the watch list, but not one I’m jumping into right now.

The Finance Ghost: Yeah, not one I’m jumping into either after this crazy run, but very frustrating to have missed stuff like this. So, final thought. Over five years, Microsoft is up 222%, Chipotle 345% and Wingstop, 390% plus. So yeah, pretty special thing. Really pretty crazy and just amazing to see if you get it right in QSR, the kind of valuation multiples you can score yourself from the market.

Mohammed Nalla: Indeed. But that’s where we got to leave it this week, so let us know what you think as our listeners, hit us up on social media. It’s @magicmarketspod, one word, @financeghost and @mohammednalla, all on X. Or go and find us on LinkedIn. Pop us a note on there. And if we bump into you in the street, feel free to buy us some interesting, either let’s call them tendies or let’s call them interesting Mexican salad bowls. If you find me here, I’m willing to try some Chipotle Mexican Grill on your dime. Until next week, same time, same place. Thanks and cheers.

The Finance Ghost: Ciao.

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