Evaluation of a Corporate Performance

Introduction

The purpose of this project is an evaluation of corporate performance using data from its annual report. The paper provides an analysis of a corporate’s strengths and weaknesses as well as a recommendation of whether to purchase the company’s stock. The analysis involves a review of the company’s statements as well as complete analysis of liquidity, financial leverage, asset management, profitability, market value, debt, per-share, measures of relative value, activity, cash flow, and assessment of management performance. After analysis, a recommendation of the corporation’s stock performance is evaluated. The company to be evaluated is Chipotle Mexican Grill.

Chipotle Mexican Grill Background Information

Chipotle Mexican Grill, Inc. is American Company which deals with a chain of fast casual restaurants ( Grill, 2015 ). The company also operates in other countries such as Canada, the United Kingdom, Germany, and France. Chipotle Mexican Grill, Inc. was founded in 1993 by Steve Ells in Denver, Colorado ( Grill, 2015 ). Ells founded the company using $85,000 loan from his father and it was estimated that the company would sell 107 burritos per day. After a month of operation, Chipotle was selling approximately 1,000 burritos per day ( Grill, 2015 ). In 1995, Chipotle began to expand, and in that year, the second store was opened funded by the cash flows from the original store ( Grill, 2015 ). During the same year, Ells and his father opened a third store using an SBA loan. Chipotle opened its fast restaurant outside Colorado in Kansas, Missouri in 1998. Chipotle was ranked 8th in 2009 and 3rd in 2010 in the list of the fastest-growing restaurant chains in the United States of America. In 2011, Consumer Reports ranked Chipotle Mexican Grill as the best Mexican fast-food chain. Since its formation, Chipotle has grown in its operations, while expanding its operations outside the United States. The company had 29 restaurants outside the United States as of 2018 including 19 locations in Canada, 6 locations in The United Kingdom, 6 locations in France, and one location in Germany ( Grill, 2015 ). 

The chipotle management team consists of residing corporate office of managers and board of directors ( Grill, 2015 ). Managers and directors are appointed to serve on audit, nomination, corporate governance, and compensation. Not a single Chipotle restaurant is franchised, all of them are owned. The corporate’s field team consist of employees working closely with certain restaurants. The four main items in the Chipotle’s menu include tacos, burritos, salads, and bowls ( Grill, 2015 ). The pricing of items on the menu varies according to the choice of steak, pork, chicken, barbacoa, carnitas, or vegetarian. The corporate’s major competitors include Qdoba Mexican Grill, Baja Fresh, Moe’s Southwest Grill, and Rubio’s Coastal Grill. The next section will cover the analysis of Chipotle’s financial statements ( Grill, 2015 ).

Financial Statement Review

Compliance with GAAP Requirements

The financial statement review will focus on how well Chipotle adhere to standards set by the generally accepted accounting principles (GAAP). Financial statements are required to meet GAAP standards in order to provide consistency in annual financial reporting. GAAP requires the provision of reports on the profit-making operations, cash flows, and overall financial conditions. Firms are also responsible for the provision of three major financial statements: balance sheet, income statement, and cash flow statement. Also, corporates must follow time and money standards; all the transactions recorded must be displayed using dollars and cents. The timeline that a given financial statement covers must vary between one year and few months. The financial statements must display the time interval for reporting in the heading of the documents regardless of how short the period is. The heading must specifically define the time, for example, “For the year ended December, 31st, 2017.”

GAAP also requires preparation of financial statements in line with matching principle using the accrual basis of accounting so that expenses match with revenues. Corporates must also adhere to full disclosure requirements by providing by disclosing all the information about the company that an investor or credit might need to assess the current financial condition of the assets. In the balance sheet, the value of total current assets, total assets, total current liabilities, total liabilities, and total liabilities and shareholders’ equity must be clearly provided. In the income statement, the value of total revenues, net income, and earnings per share must be clearly recorded. Also, net cash provided by operating activities, net cash provided by investing activities, and net cash used in financing activities must be provided in the statement of cash flows.

The financial statement review was conducted on the financial information found in the Chipotle annual report as of December 31st, 2017. Chipotle provided the three major financial statement; balance sheet, income statement, and statement of cash flows in its annual report. Also, the values of transactions recorded were in dollars and cents. The heading for each financial statement is correct as per the requirements of GAAP. The heading consists of three lines: the first line contains the name of the corporate (Chipotle Mexican Grill, Inc., the second line is the type of financial statement, while the third line is the timeline for financial reporting indicates as, “For the fiscal year ended December 31st, 2017.” Chipotle adheres to full disclosure requirements. The information that is essential for investors and creditors such as assets, liabilities, owners’ equity, cash flows, revenues, and expenses are fully disclosed in the financial statements.

Additionally, Chipotle’s financial statements are prepared in line with matching principle using the accrual basis of accounting whereby all its expenses for the fiscal year 2017 are listed to match the revenues. In the Chipotle’s balance sheet, the value of total current assets, total assets, total current liabilities, total liabilities, and total liabilities and shareholders’ equity are clearly provided. Also, the value of total revenues, net income, and earnings per share are provided in its statement of income. Further, net cash provided by operating activities, net cash provided by investing activities, and net cash used in financial activities are provided in its statement of cash flows. Generally, Chipotle’s financial statements adhere to standards set by generally accepted accounting principles (GAAP).

Financial Statements for the Next Fiscal Year

The 10% growth rate in sales and cost of goods sold will increase revenues by 10% as well as the cost of goods sold by 10%. This will have an effect on the net income in the statement of income as well as inventories and retained earnings in the balance sheet. The next year’s Pro Forma statements are as follows.

Chipotle Mexican Grill, Inc.

Income Statement

For the Fiscal Year Ended December 31st, 2018

Revenue	$4,924,053.20
Restaurant operating costs (exclusive of depreciation and amortization shown separately below):
Food, beverage and packaging	$1,688,970.80
Labor	$1,326,591.20
Occupancy	$359,845.20
Other operating costs	$716,808.40
General and administrative expenses	$326,026.80
Depreciation and amortization	$179,682.80
Pre-opening costs	$13,575.10
Loss on disposal and impairment of assets	$14,679.50
Total operating expenses	$4,626,179.80
Income from operations	$297,873.40
Interest and other income, net	$4,949.00
Income before income taxes	$292,924.40
Provision for income taxes	-$99,490.00
Net income	$193,434.40

Chipotle Mexican Grill

Balance Sheet

For the Fiscal Year Ended December 31st, 2018

Current assets:
Cash and cash equivalents	$ 184,569
Accounts receivable, net of allowance for doubtful accounts of $0 and $259 as of December 31, 2017, and December 31, 2016, respectively	40,453
Inventory	19,860
Prepaid expenses and other current assets	50,918
Income tax receivable	9,353
Investments	324,382
Total current assets	629,535
Leasehold improvements, property, and equipment, net	1,338,366
Long-term investments	0
Other assets	55,852
Goodwill	21,939
Total assets	2,045,692
Current liabilities:
Accounts payable	82,028
Accrued payroll and benefits	82,541
Accrued liabilities	159,324
Total current liabilities	323,893
Deferred rent	316,498
Deferred income tax liability	814
Other liabilities	40,042
Total liabilities	681,247
Shareholders' equity:
Preferred stock, $0.01 par value, 600,000 shares authorized, no shares issued as of December 31, 2017 and December 31, 2016, respectively	0
Common stock $0.01 par value, 230,000 shares authorized, and 35,852 and 35,833 shares issued as of December 31, 2017 and December 31, 2016, respectively	359
Additional paid-in capital	1,305,090
Treasury stock, at cost, 7,826 and 7,019 common shares on December 31, 2017, and December 31, 2016, respectively	(2,334,409)
Accumulated other comprehensive income (loss)	(3,659)
Retained earnings	2,397,064
Total shareholders' equity	1,364,445
Total liabilities and shareholders' equity	$ 2,045,692

Ratio Analysis

Liquidity Ratios

Liquidity ratios of a company are the ratios between its liquid assets and its liabilities. Liquidity ratios measure a corporate’s ability to meet its current obligations with its liquid assets. The two liquidity ratios that are used in this project are the current ratio and cash ratio. 

Current Ratio

The current ratio is the ratio between a corporate’s current assets and current liabilities. The current ratio measures a company’s ability to cover its current liabilities with its current assets. It measures the amount of working capital a corporate has. 

As of December 31st, 2017:

Chipotles total current assets = 629.5 million

Chipotle’s total current liabilities = 323.9 million

Chipotle’s current ratio = × 100%

 × 100% = 194%

Chipotle’s current ratio is healthy. 194% current ratio means that its current assets are 94% more than its current liabilities (current asset is almost double the current liabilities). Chipotle has sufficient current assets to meet its current obligations.

Cash Ratio 

Cash ratio is the ratio between a corporation’s cash and cash equivalents and its current liabilities. It is a liquidity ratio measuring the ability of a company to meets its current obligations with the available cash,

Cash Ratio = × 100%

As of December 31st, 2017:

Cash ratio = 157%

Chipotle’s available cash is 57% more than its current liabilities. Thus, the company is in a position to meet its current liabilities with the available cash.

Financial Leverage Ratios

Financial leverage ratios measure the overall debt burden of a corporate. These ratios provide an overall debt picture of a company. A corporate is considered highly leveraged if the creditors own the majority of assets. Some of the financial leverage ratios are debt ratio and debt-to-equity ratio.

Debt Ratio

The debt ratio is the ratio between a company’s total liabilities to total assets. It measures the percentage of assets financed by debt. It shows the percentage of assets a firm must sell to pay off its liabilities.

Debt Ratio = × 100%

Chipotle’s Debt ratio =33.30%

This implies that 33.30% of the company’s assets are financed by debt. Chipotle has to sell 33.30% of its assets to pay off debts. Thus, Chipotle is able to pay off its debts.

Debt-to-Equity Ratio

Debt to equity ratio is the ratio between a company’s total liabilities to its total equity. A higher debt to equity ratio shows that the company is financed with more debt than equity

Debt-to-equity ratio = × 100%

Chipotle’s Debt-to-equity ratio =50%

This means that there is a half as many liabilities as there are equities. Investors own 66.7% of Chipotle’s assets while creditors own 33.3% of assets.

Asset Management Ratios/ Activity Ratios

Asset management ratios measure the success of a company in managing its assets while generating sales. These ratios include inventory turnover ratios and fixed asset turnover ratios.

Inventory Turnover Ratio

Inventory turnover ratio measures how quickly a firm’s inventories are being sold. A higher inventory turnover ratio is good for a company.

Inventory turnover ratio =  =

Chipotle’s inventory turnover ratio =213.32

Fixed Assets Turnover Ratio

Measures how productively a firm is managing its net fixed assets to generate sales.

Fixed assets turnover ratio =  

Chipotle’s fixed turnover ratio =3.39

Profitability Ratios

Profitability ratios measure a company’s ability to generate earnings relative to its associated expenses. A firm with a profitability ratio more than its previous ratio indicates that it is doing well financially. They include return on asset, return on equity and net margin.

Net Margin

Net margin measures a company’s profitability at different cost levels.

Return on Assets

Return on assets measures a company assets’ profitability at various cost levels.

Profitability Ratio	2016	2017
Net Margin	40.79%	36.08%
Return on Assets	0.97%	8.66%
Return on Equity	1.30%	12.74%

Market Value Ratios/ Measures of Relative Value

Market value ratios are used by investors to determine if a corporation’s shares are underpriced or overpriced. They include book value per share, earnings per share, and price/ earnings ratio.

Book value per share

It is the amount of stockholders’ equity divided by a number of shares outstanding.

Chipotle’s book value per share =49.49

Earnings per share

Earnings per share are the reported earnings of business divided by the number of outstanding shares.

Chipotle’s earnings per share = 6.17

Calculation of Return on Equity Using DuPont System

According to the DuPont Model:

Return on Equity = Net Profit Margin × Asset Turnover × Equity Multiplier

Net profit margin = 0.0394

Asset turnover = 2.20

Equity multiplier  = 1.5

Return on Equity = 0.0394 ×1.5 ×2.20

= 13%

Economic Value Added

Economic Value Added = Net operating profit after tax – (Capital Invested ×WAAC)

WACC = × Cost of Equity +  × Cost of Debt × (1- Tax Rate)

E= Market Cap = 12.72 billion, D=Book value of debt =0

Therefore, weight of equity =1 and weight of debt =0

Thus: WACC =Cost of Equity

Cost of equity = Rf + β (Rm –Rf)

Chipotle Mexican Grill β =0.69

10-Year US Treasury Bonds Rates =2.91%

Market premium, (Rm –Rf) =6%

Cost of Equity =2.91% +0.69×6% =7.05%

Therefore, WACC = 7.05%

Economic Value Added = Net operating profit after tax – (Capital Invested ×WAAC)

= 176,253,000 -(0.0705 ×1,364,445)

= 176,253,000 -95,511,150

=80.74 million

The EVA of 80.74 million means that the company is generating 1.073 from funds invested on it. It means the investors are paid 80.74 million for investing in Chipotle Mexican Grill, Inc.

Findings and Recommendations

Generally, Chipotle Mexican Grill, Inc. is a good performing company. The company adheres to all standards of the generally accepted accounting principles (GAAP) hence safe from any charges and fines due to noncompliance and fraud. Also, Chipotle has a healthy liquidity ratio; it can meet all its current obligations with the current assets as well as cash and cash equivalents. Also, the Company has a healthy financial leverage ratio; the majority of the company is financed by shareholders. Chipotle’s debt burden is low, hence able to acquire more debt in future for expansion.

Additionally, Chipotle has efficient asset management with healthy turnover ratios. The Company’s economic value added is high, thus the investors earn more for investing in Chipotle Mexican Grill. The return on equity is approximately 13% which implies investors will earn a return of 13% on investment which is greater than the weighted average cost of capital (WACC). The company’s price per earnings ratio average is 80.5 which is above the industry’s average. Also, price/sales and price/cash flow of the company is above the industry’s average. Chipotle also experienced a large increase in the return on equity between 2016 and 2017. According to the findings, Chipotle’s stock performance is good for investment. I will, therefore, recommend the purchase of Chipotle Mexican Grill, Inc. stock.

Financial Risks Associated with Operating Internationally

Chipotle Mexican Grill, Inc. faces three financial risks associated with operating internationally: price risk, interest rate risks, and currency risk. The company faces the risk of fluctuating prices in foreign countries. Some of these risks cannot be hedged by forward contracts because the majority of ingredients are purchased at spot market. The company’s financial leverage is poised to rise when expanding internationally, thus facing high interest rate risk. Foreign exchange rates are highly volatile. Chipotle may face the risk of fluctuating exchange rates when it goes international. 

References

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Chipotle Mexican Grill, Inc. (CMG) (2018). Profile, business, summary. Morningstar. Retrieved from http://financials.morningstar.com/valuation/price-ratio.html?t=CMG&region=usa&culture=en-US

Chipotle Mexican Grill, Inc. (CMG) (2018). Profile, business, summary. Yahoo! Finance. Retrieved from https://finance.yahoo.com/quote/CMG/balance-sheet?p=CMG

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