Chipotle Case Financial Statement Analysis and Growth Modeling

MBAC 6060 – Spring 2011

David M. Gross, Ph.D.

Chipotle Case – Financial Statement Analysis and Growth Modeling

The first purpose of this assignment is to review financial statement analysis and to reinforce the definitions and interpretations of common financial statement ratios.

The second purpose is to gain experience using pro-form financial statements to model change in the firm and to analyze the consequences of different financing policies.

Please carefully read the instructions below and use the associated Excel file to produce with your group a report that answers the assignment question.

Please include in your printed document the financial statements you produce. These include

A common-size income statement and balance sheet for Chipotle for 2009 and 2008
A common-size income statement and balance sheet for McDonalds in 2009
Various pro-form (projected) 2010 regular and common-size income statements and balance sheets for Chipotle under various growth and financing assumptions (see the instructions below)

I have also provided two tables under the “Tables” tab of the case spreadsheet which you should use when printing your results. (Using the tables makes it easier for me to grade the assignment.)

Overview:

You are a financial manager working for Chipotle Mexican Grill (ticker: CMG) and you will write the internal financial planning and analysis (FP&A) report for the firm. To do this, you have at your disposal the 2009 and 2008 income statements and balance sheets for Chipotle and the 2009 income statement and balance sheet for McDonalds (MCD). You also have the price of both companies’ stocks on the day that financial statements were prepared. For each portion of the analysiscompare CMG’s 2009 results to its 2008 results and compare CMG’s 2009 results to MCD’s 2009 results.

In addition, you have been asked to consider sales growth forecasts and compare the effects of different alternatives for financing growth (paying for new assets). One possibility is to issue new equity to finance growth and the other is to use the company’s cash. You will build Excel models to assess the effects of the financing options on solvency, profitability and efficiency for various projected growth rates.

Please work with your group to produce a printed report containing the tables and financial statements you are asked to produce along with short written answers to the questions in the assignment.

Background:

From the Wikipedia page: Chipotle Mexican Grill, Inc. is a chain of fast-casual restaurants in the United States and Canada specializing in burritos and tacos. It was founded by Steve Ells in 1993 and based in Denver, Colorado. The name Chipotle derives from the Mexican Spanish name for a smoked, dried jalapeño chili pepper, and ultimately derives from the Nahuatl language.

The restaurant is known for its large burritos, assembly line production, and use of natural ingredients. The company has released a mission statement called Food with Integrity, which highlights its efforts in using organic ingredients, and serves more naturally raised meat than any other restaurant. Chipotle is one of the first chains of fast casual dining establishments. From 1998 to 2006, McDonald's Corporation owned a majority interest in Chipotle, but fully divested their interest in 2006.

The company currently has more than 1000 locations, with restaurants in 38 states, the District of Columbia, Ontario, Canada, and London, England. Its net income in 2009 was US$126 million, and has a staff of 25,000 employees.

Chipotle has had 23% average sales growth over the years 2007, 2008 and 2009.

Part 1: Financial Statement Analysis

The goal is to compare CMG over time and to one of its comparable companies.

Use the Income Statement and Common-Size Income Statements to describe CMG’s operations in 2009 relative to 2008 and relative to MCD in 2009. Consider revenue and the relative level of expenses. Do you notice changes for CMG over time or differences between CMG and MCD? Describe whether or not your findings are consistent with what you know about the companies.

Use the Balance Sheets and Common-Size Balance Sheets to compare CMG’s asset mix in 2009 to its asset mix in 2008 and to MCD’s asset mix in 2009.

Please note the portion of short-term assets (and specifically cash) on the common-size balance sheets. How much cash does CMG have at the end of 2009 relative to 2008 and relative to MCD? What might explain the change in cash over time and the difference between CMG and MCD?

Hint: Generally, if a mature firm (with a relatively high payout ratio) holds cash, it will have an offsetting liability and therefore incur higher interest expense. Consider your analysis of the cash balance in this context.

Use the Balance Sheets and Common-Size Balance Sheets to compare CMG’s liability mix and debt-equity mix in 2009 to itself in 2008 and to MCD in 2009.

To simplify the analysis, assume that securities (bonds) issued by the firm are recorded as “Long-Term Debt” on the balance sheet and capitalized lease obligations of the firm are recorded as “Other Long-Term Liabilities.”

Use the balance sheets and income statements to calculate Days’ Sales in Inventory for CMG in 2009 and 2008 and MCD in 2009. Compare the results. What does this say about the frequency of food deliveries and storage expenses?

Now assume that MCD has chosen the “correct” level of inventory relative to sales. Increased inventory is a way to hedge against unexpected sales volatility (to ensure that you don’t run out of burritos or French fries). If CMG were to increase its inventory to the same relative level as MCD (as measured by days’ sales in inventory) assume this would result in an increase in “Other Current Liabilities.” Calculate the increase in interest expense if the marginal short-term borrowing cost is 3.00%.

Use the balance sheets to calculate the Current, Cash and Quick Ratios for CMG in 2009 and 2008 and MCD in 2009. What is the difference between these ratios? What is excluded as the ratios change?

Compare the results. What do these ratios tell us about CMG’s ability to meet its debt in the short run compared to MCD?

Use the balance sheet and income statements to calculateEarnings per Share, EBITDA, the Price-to-Earnings Ratio, the Price-to-EBITDA Ratio, the Price-to-Sales Ratioand the Market-to-Book ratios for CMG in 2009 and 2008 and MCD in 2009.

Describe the differences between these valuation ratios. What are you removing as you move from one price-numerator ratio to the next?

Compare these relative valuation measures across time and companies. How is the market valuing CMG in 2009 compared to 2008 and to MCD in 2009? Which company does the market expect to grow more?

Use the balance sheet and income statements to calculate ROE, EM, ROA, AT and PM for CMG in 2009 and 2008 and MCD in 2009.

These are the components of the DuPont Identity and can be used to decompose profitability. Recall for this analysis, ROE is the sole measure of profitability, EM measures leverage and ROA (and its components AT and PM) measure efficiency.

Compare CMG in 2009 to CMG in 2008. Did profitability increase or decrease? To what can you attribute the change?

Compare CMG to MCD in 2009. Which had the greater profitability? To what can you attribute the difference? What are the implications of the difference? What recommendations might you make to CMG operations management in order to increase profitability?

Note that you will find that MCD is better at controlling expenses. Examine the income statements to determine which expenses are driving this result. Are your recommendations consistent with the CMG’s mission?

Calculate the current Plowback Ratio, the Internal Growth Rate and Sustainable Growth Rate for CMG. Briefly define each growth rate. What is the effect on the D/E ratio if the firm grows at the Internal Growth Rate? What is the effect on the D/E ratio if the firm grows at the Sustainable Growth Rate?

Part 2: Growth Models

The goal is to build a spreadsheet model to examine the effects of different growth rates and financing policies on the financial performance of CMG.

Calculate the components of External Financing Needed (EFN) and the EFN for CMG in 2009. Use formula on Chapter 3 Slide 51 and reference a sales growth rate entered into cell C79 in the spreadsheet. Assume A/P is the only spontaneous liability.

Next, in cells M7 through N51, create regular and common-size 2010 pro-formaincome statements and balance sheets for CMG that reference the growth rate entered into cell C79. Assume:

Every item in the income statement grows proportionally with sales. This is the same as assuming no change in either sales or expense efficiency.

Assume no change in dividend policy. This means all NI will be retained.

All asset categories grow at the sales growth rate. This means the asset mix does not change. To do this let each asset account value equal the current value multiplied by one plus the growth rate. For example, cell M25 = C25*(1 + C$79). The “$” in front of the “79” locks that row reference.

(Check to make sure your Total Current Assets, Total Long-Term Assets and Total Assets cells are correct.)

Only A/P grows at the sales growth rate (just like the assets)so cell M37 = C37*(1 + C$79). All other liabilities do not change. This is same as saying A/P is the only spontaneous liability. (Check to make sure your Total Current Liabilities, Total Long-Term Liabilities and Total Liabilities cells are correct.)

Retained Earnings in the pro-formabalance sheet increases by the “Increased RE from New Sales” calculated in cell C82 so M48 = C48 + C82.

Use “Common Stock, Net”in cell M47 as the plug value. The plug value is the account that you adjust in order to make the balance sheet “balance.” So enter a formula into “Common Stock, Net” such that it equalsTotal Assets less Total Liabilities less Retained Earnings. Note that the difference between “Common Stock, Net” in the 2009 and pro-forma balance sheets is the EFN. (Check to make sure your Total Equities and Total Liabilities and Equities cells are correct.)
Enter a growth rate of 25% into cell C79. If your spread sheet works correctly, changing the “Projected Sales Growth” in cell C79 will cause the EFN in cell C83 and the values in thepro-forma balance sheet to change. If Projected Sales Growth Equals in cell C79 is 25%, EFN in cell C83 will equal $75,513 and Common Stock, Net in the pro-forma balance sheet in cell M47 will equal $501,441.

Copy and paste the cells that calculate the short-term solvency ratios (Current, Quick and Cash Ratios)in the same rows under the new pro-forma financial statements (column M).

Copy and paste the cells that calculate profit, leverage and efficiency (the DuPont Identity Cells ROE, EM, ROA, AT and PM) to column M.

If your spread sheet works correctly, the Current Ratio in cell M58 will equal 3.43 and ROE in cell M69 will equal 16.91%. Note that ROA, PM and AT are not effected by sales growth. Why?

Use the model to examine the effects of different growth rates and financing policies on the financial performance of CMG.

(a)As an exercise, first assume sales will grow at exactly the Internal Growth Rate (which is 15.20%). To avoid a rounding error, set cell C79 equal to cell C76, don’t just type in the number.

Compare the EFN at the Internal Growth rate to the “Liabilities Automatically Created by New Sales” in cell C81. Explain your findings.

What are the effects on the firm’s short term solvency if it grows at the internal growth rate? (Does short-term solvency improve or deteriorate?) Why?

What are the effects on the firm’s profitability, leverage and efficiency if it grows at the internal growth rate? (Do these measures improve, stay the same, or deteriorate?) Why?

(b)Now assume sales will grow at 25% (enter 25% into cell C79).

Record the results for the liquidity, profitability and efficiency ratios from the projection in Table 2 on the “Tables” tab.

Now assume CMG is considering a change in its financing policy. It is considering using accumulated cash(from past and current retained earnings) to pay for new assets instead of selling new equity. This means you must adjust your modelto account for the change in the financing policy.

There are a number of ways to adjust your model. Here’s one that will preserve the original model so that you won’t lose those results:

Right-click the sheet tab at the bottom of the spreadsheet and select “Move or Copy”

Check the “Create a Copy” box and click OK

Right-click the new tab and rename it “Cash Financing”

(a)Adjust your pro form balance sheet to reflect the growth level and new financing policy. So now “Cash and Cash Equivalents” is the plug value.

All assets (except cash) will grow at the sales growth rate, so the formulas do not change
A/P still grows at the sales growth rate so M37 = C37*(1 + C$79)
No other liabilities change values.
Retained Earnings in the pro form balance sheet still increases by the “Increased RE from New Sales” calculated in cell C82 so M48 = C48 + C82.
The new financing policy means new equity is not issued so M47 = C47.
Set “Cash and Cash Equivalents” equal to “Total Liabilities and Equity” less all the non-cash assets. This is the plug value.

So cell M24 = M51 – M33 – M27 – M26 – M25 = $261,445 (at 25% growth)

Be sure that your “Totals” values are calculated correctly and that your balance sheet “balances.”
Note that Total Assets in the pro-forma no longer equals 2009 Total Assets multiplied by one plus the growth rate. Why? Because CMG will use cash to buy new assets.

Record the results for the liquidity, profitability and efficiency ratios from the projection in Table 2 on the “Tables” tab.

(b)Next calculate the maximum sales growth CMG could finance using existing cash. Assume the minimum cash holdings can be no less than 10% of total assets (MCD holds less than 6%) and that any additional cash may be used to finance growth. (Note we will still assume that A/P growth is spontaneous, so that portion of growth will be financed by suppliers.)

To do this, first copy and create a new spread sheet (called Max Growth) so you don’t lose the results from above.
Change the sales growth value in Cell C79 until the common-size pro-forma “Cash” in cell N24 is 10% of Total Assets. You may want to use the “Solver” or “Goal Seek” Excel functions instead of changing the cell manually.

Record the results for the liquidity, profitability and efficiency ratios from the projection in Table 2 on the “Tables” tab.

Part 3: Growth Analysis

We now have the ability to compare the effects of differing growth rates and financing policies on the performance of the company. For each growth scenario, place the short-term solvency ratios and the profit, leverage and efficiency measures you calculated in Table 2 on the Tables tab.

Compare the short-term solvency for 25% sales growth under the 2 financing options (selling equity or using existing cash). Under which option does the firm have better short-term solvency? How does the resulting short term-solvency compare to the current 2009 values? How does it compare to MCD?

Compare the long-term solvency (EM). Are the long-term solvency results consistent with the short-term solvency results?

Compare the profitability (ROE) for 25% sales growth under the 2 financing options. Under which option is the profitability greater? Explain why.

Compare the overall efficiency (ROA) for 25% sales growth under the 2 financing options. Under which option is the ROA greater? Explain why.

Compare the components of overall efficiency (AT and PM) for 25% sales growth under the 2 financing options. How do the different financing options affect the components of efficiency? Explain why.

Look at the results for max growth using cash. How do the solvency, profitability and efficiency measures under this scenario compare to the other results?

Given your analysis, write a brief recommendation suggesting a financing policy. Support your recommendation with the results from the analysis.