Chipotle's Strengths Will Drive Further Gains in 2014

Chipotle Mexican Grill (NYSE: CMG) had a tremendous 2013, as evidenced by the market-beating 77% increase in the company's share price during the year. While market-beating returns are great, long-term investors should be more excited by the way that Chipotle executed its growth strategy. By focusing on a few core principles, Chipotle has continued to differentiate itself from the competition and proven to be an exceptional business.

The restaurant industry is crowded, and there is no shortage of competition for consumers in search of a good burrito. On the fast food end of the spectrum, Yum Brands' (NYSE: YUM) Taco Bell franchise continues to dominate in terms of size and price. In casual dining, Chuy's Holdings and many others provide significant competition thanks to a wide range of menu offerings. Chipotle operates in the fast casual sweet spot that combines the speed of fast food and higher-quality products. The company is by no means the only fast casual burrito specialist; Jack in the Box's (NASDAQ: JACK) Qdoba restaurants are one of many brands that target the same customer that Chipotle does.

Chipotle has managed to stand apart from this competition through very simple strategic decisions.

Product differentiation
Chipotle's "food with integrity" mantra has been a consistent theme throughout Chipotle's history of rapid growth. This mission to source ingredients in a way that is friendly to animals, farmers, and the environment has resonated with customers for three reasons. First, there is the obvious "feel good" message of supporting local farmers and protecting animals and the environment. Second, the focus on fresh and naturally raised ingredients clearly parallels the megatrend toward healthier eating that is under way across the United States. Third, the quality of ingredients leads to a noticeably fresher and appetizing meal than anything found at a Taco Bell, including the Cantina Bell menu.

While taste is largely a subjective observation, what is observable is consumer traffic. In Chipotle's most recent earnings release, same store sales (SSS) increased 6.2%, which is more than triple the 2% SSS increases reported by Qdoba and Taco Bell (United States) during comparable periods.

Disciplined growth
Chipotle has been a successful investment thanks to the tremendous growth the company has experienced on its way to over 1,500 locations. However, it is noteworthy that the company has taken a deliberate and controlled approach to growing the Chipotle brand. This discipline is demonstrated by the company's pristine, debt-free balance sheet. While Chipotle could certainly issue debt to finance growth and still remain a solid investment, the fact that the company's cash flow enabled it to increase its store count by more than 10% during 2013 is impressive.

What really sets Chipotle's growth strategy apart is the company's commitment to own all of its restaurant locations. A franchise model can accelerate growth and be profitable, but the decision to retain control over every Chipotle location provides management with the ability to control quality and the customer experience in a way that Yum Brands, Jack in the Box, and others cannot.

People-first culture
Customers that attempted to eat at Chipotle on Thanksgiving, Christmas, or New Years Day may have been disappointed to find that the local Chipotle was closed. 

Source: Chipotle Facebook Page

Unlike its competitors, Chipotle closes for major holidays (including Easter and July 4th as well) so that employees can spend time with family and enjoy the holidays. This is just one of many ways that Chipotle approaches business differently than its competitors; the company has a unique approach to training and developing employees that has led to the impressive statistic that 97% of Chipotle's salaried managers were promoted internally from hourly positions. 

A winning recipe
The merits of quality ingredients, prudent expansion, and happy employees are simple concepts to understand. However, Chipotle's dedication to each is unmatched among its competition, which has created a very powerful competitive advantage. This advantage drove Chipotle to new heights in 2013, and there is little reason to doubt that this trend will continue in 2014.