What Chipotle Can Learn From Starbucks

What Chipotle Can Learn From Starbucks

With a market cap of $12.5 billion, and a P/E over 40, ChipotleMexican Grill has investors wondering if it can maintain the long-term growth rate necessary to justify its high valuation. And considering Chipotle shares already tanked once following a slowdown in sales growth, investors may fear a similar tumble.

With a market cap of that size, Chipotle is already one of the largest restaurant companies on the market. Larger peers McDonald's and Yum! Brands trade for the much more modest earnings valuations of 17 and 23, as the two older chains dwarf Chipotle in size. Compared to just 1,500 total Chipotle locations, there are about 35,000 McDonald's restaurants around the world, and over 39,000 restaurants under Yum's umbrella, which includes KFC, Pizza Hut, and Taco Bell. With such a large footprint already, a significant expansion is nearly impossible for McDonald's and Yum.

However, there's one larger restaurant chain that could serve as a model for Chipotle as it grows into its lofty valuation- -- Starbucks . The coffee empire has rebounded from a recession-era share price below $9, to over $70 today, or a gain of approximately 700%. It's now worth over $50 billion, but still carries a P/E ratio of 34, meaning the market expects its torrid growth to continue. In its latest quarterly report, Starbucks grew its earnings per share a whopping 28%, to $0.55, on a 13% increase in revenue. That compares to just a 1% sales increase for Yum Brands and McDonald's in their latest reports.

Starbucks grew its comps 8% in the quarter, saw its operating margin jump 150 basis points to 16.4%, and opened 341 stores to bring its grand total to 19,209.

What's brewing inside
Despite Starbucks' numerous partnerships, co-branding initiatives, and steps to add new technologies like mobile payments, its growth is still driven primarily by simply adding new stores and growing sales within its current stores.

In its most recent quarter, Starbucks' strong organic growth was paced by increasing sales in the Americas and China Asia-Pacific regions, as Europe continues to pull out of a recession. The vast majority of sales come from its Americas region where revenues grew 12% in the quarter, and operating margin improved to 22.3%, but the Far East has proven to be a juggernaut. In the Asia/Pacific region, sales increased 29% and operating margin reached a stellar 36.2%. As we've seen with many other American brands across the Pacific, the Asian market is clearly hungry for Starbucks.

On the earnings call, CEO Howard Schultz noted the company's "flywheel" strategy, which leverages digital, loyalty, and mobile capabilities, and uses Starbucks' brand partnerships to further drive profitability. The extensions Starbucks has made across the high-end beverage market in recent years are unparalleled. While some observers once saw Green Mountain Coffee Roasters' Keurig single-cup brewing system as a threat to Starbucks' more-expensive cup of Joe, the coffee chain, after initial resistance, partnered with Green Mountain and began producing its own K-cups. It just shipped its one-billionth branded K-cup in the last quarter. Similarly, the company has made a number of acquisitions, including Tazo, Teavana, and Evoultion Fresh, which give it further growth opportunities, and leverage its operational excellence. With its mastery of the coffee market, it only makes sense for Starbucks to set its sights on tea and fresh juice. Starbucks is also continually introducing new menu items such as its Clover-branded french press coffee, La Boulange baked goods, or the Valencia Orange Refresher

Finally, Starbucks' inroads into digital payments have been a savvy strategy to improve efficiency and increase brand loyalty. Dollars loaded on Starbucks cards grew 30% from a year ago, and dollars loaded via mobile and the web nearly doubled. The Starbucks card is now used in almost a third of all U.S. transactions, and more than 10% of its domestic sales are now done through its mobile app.

Lessons for Chipotle
In many ways, the burrito roller is already following in the footsteps of the coffee giant. Chipotle's recent decision to expand its Sofritas offering shows that management is not afraid to shake up its menu and stay ahead of the competition by offering a tofu-based meal that provides an option for vegetarians. As Chipotle matures, it will hopefully take similar steps to keep its menu fresh, and offer customers some variety. In the way that Starbucks has branched out with Teavana and Evolution Fresh, Chipotle has made a similar effort by opening its ShopHouse Southeast Asian Kitchen. While ShopHouse is just in its infancy, with its third and four locations set to open this month, it gives Chipotle another way to assert its dominance of the high-quality fast-casual segment, the way Starbucks has become synonymous with high-end coffee.

Starbucks' success abroad also looks promising for Chipotle, which has just begun to open stores in Europe. Though the majority of its sales still come from the US, the coffee chain now operates in 60 countries, and has seen incredible in growth in Asia of late. The popularity of other fast food chains abroad such as McDonald's, KFC, and Subway also bodes well for Chipotle's international expansion plans.

Foolish bottom line
The coffee market, of course, has several key differences from the burrito market, and Chipotle cannot emulate Starbucks in every way. Coffee is a much stickier product than burritos, meaning Starbucks customers visit its stores more frequently, because coffee tends to be consumed daily, or even multiple times a day. Similarly, coffee lends itself more to consumer products, and co-branding and licensing opportunities, as the product is simply more flexible and adaptable by its nature.

Above all, however, Starbucks serves as a model of how to create a stellar food-service brand with multiple growing revenue streams. Chipotle would be mindful to follow its lead as a symbol of high quality, which means continuing to raise its "Food with Integrity" standards as they are an important differentiator from its competitors. Chipotle will also need to keep innovating both in new products as well as other areas like payment options, and continue to take advantage of market opportunities as they arise.

As Starbucks has shown, establishing brand dominance enables enormous growth opportunities. Even after two decades of expansion, the company has no plans to slow down. It expects to open 1,400 new stores in its next fiscal year, and grow earnings 18% to 22%. With only 1,500 stores currently, Chipotle looks minuscule by comparison. Its investors can only hope that, in 20 years, the burrito chain is boasting numbers like Starbucks' today.

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The article What Chipotle Can Learn From Starbucks originally appeared on Fool.com.

Fool contributor Jeremy Bowman owns shares of Chipotle Mexican Grill. The Motley Fool recommends Chipotle Mexican Grill, McDonald's, and Starbucks. The Motley Fool owns shares of Chipotle Mexican Grill, McDonald's, and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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