The Tasty Details From Chipotle

In this podcast, Motley Fool analyst Sanmeet Deo and host Ricky Mulvey break down earnings from Chipotle and changes at Southwest Airlines.

Then Motley Fool analyst Asit Sharma joins Ricky to discuss one of Warren Buffett’s favorite metrics.

To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on July 25, 2024.

Ricky Mulvey: This seat is not open, but you’re listening to Motley Fool Money. Hey, I’m Ricky Mulvey. Joined today, by Sanmeet Deo. Sanmeet, how are we doing?

Sanmeet Deo: Hey, Ricky. Good.

Ricky Mulvey: Let’s talk Chipotle. Because if the restaurant industry is hurting, don’t tell this fast-casual chain, Chipotle just posted earnings yesterday. Revenue up 18%. Same store sales number caught my attention at 11%. Thank you pricing hikes for Chipotle shareholders. They also opened up 52 new restaurants in the quarter. This is a smaller detail, but I’d like to see it. They achieved their goal of promoting 90% of people from within the company. A menu of takes for your Chipotle order. What are your headlines?

Sanmeet Deo: A component of that same store sales growth of 11%. A key part of that was transaction growth, which was about 8.7%, and they’re continuing to see that drive their sales growth, and they’re seeing it in the next quarter with early signs in July. This is a good indicator because it means that customers are buying more and their sales are being driven by that rather than just price increases and they’re seeing transaction growth across all income cohorts. That was one big key takeaway. Another one was that they’re seeing actually a very healthy consumer that’s spending. They’re also very positive on the restaurant industry in general. I like to see that macro insight there. They are pumping the brakes on price increases. They would prefer not to do them if they can. They will if they need to, but they did indicate on the call that they’re really not looking to.

Ricky Mulvey: More people are coming in while they raise prices. That’s pretty good. CEO Brian Niccol, also getting ahead of that social media trend where people had been filming Chipotle workers to make sure they are getting proper portions. Is that cyberbullying Sanmeet? I’m going to call it cyber bullying.

Sanmeet Deo: It’s sort of, it’s an element of.

Ricky Mulvey: It’s a little bullying. But basically, Niccol acknowledged that there is variance across their 3,500 stores. That’s a lot of them, and also said that the company is reemphasizing training and coaching, not putting any blame on the people filming and looking at especially the outliers where portion sizes are a little different. What did you think a Niccol’s response here?

Sanmeet Deo: I think he did a great job addressing this. He addressed it head on right at the beginning of the call. He wasn’t dismissive of his customers and what their issues were. He took them seriously. Then he said that they went back, looked at the problem and analyzed the system, see how they could improve. It actually turns out that it was a relatively small percentage of stores, about 10% that were not, giving generous portions, which is something they feel is a very important component of their business.

Ricky Mulvey: I feel it. I’m not filming anyone at Chipotle. But I feel it when they’re giving me my portion of chicken al pastor steak. I see him do that little spoon shake to get and I’m like no, there’s something animalistic, Sanmeet, where I’m like you’re taking away my meat. How dare you and you just just raise prices? There was a big announcement for me, at least that chicken al pastor, the limited time offer is out at the end of the summer, smoked brisket coming back in the fall. Is this return meaningful to you? For a more businessy question, how did these limited-time offers? What do they do for Chipotle?

Sanmeet Deo: When they announced that chicken al pastor is coming back, I was super pumped. I love that stuff. For the smoke brisket, I personally don’t eat beef, so I’m not as excited, but as a shareholder of Chipotle and a fan of Chipotle, I think it’s fantastic. I think these limited time offers, is what they call them are great for Chipotle. It generates enthusiasm, traffic to their stores. They even highlighted the chicken al pastor as being a significant tributor to their traffic growth in the quarter. They prepare them well. They craft these items really nicely. Then they throw them out there for the wolves to go after.

Ricky Mulvey: The regular chicken compared to the al pastor. It doesn’t hold a candle. It’s going to be rough. Anyway, we’re long term investors, but the stock is interesting right now, really whipsawing on the results. You look through the transcript of the call, and almost all of the analysts are congratulating Chipotle on the great quarter. Looks like they have some great comps schemes, same store sales. What’s the street reacting to?

Sanmeet Deo: I saw the results, and I was like, this is awesome. Then I saw the aftermarket results of the stock, and it was up at one point up to 14%. Then it slowly started coming down, mostly likely profit taking. Then, as a call progressed, there’s a single comment where they said, margins are expected to be under pressure for the next couple of quarters. That seemed to bring the stock down even more. I think the streets worried about higher food costs, lower margins. They were at about 20% for this quarter. They’re looking to see it come down to about 25%. Management thinks this is a seasonal issue, nothing that’s too worrisome, and that they can offset it with, investment and efficiencies and even prices, if needed. But this is a classic example of with analysts congratulating them. Classic example of fundamentals doing very well, stock not reacting in the way you might expect it to, which for me is a long term investor lights me up.

Ricky Mulvey: Congratulations in the front and sales in the back. You’re a long term investor. Why do you plan on holding your Chipotle shares for a while then?

Sanmeet Deo: I think this company is knocking the ball out of the park with their promotions, with their food, their quality, their growth. Chipotle has about over 3,000 stores, and they’re looking to get to about 7,000 in North America. They’re growing internationally. I think they just opened their store in the Middle East. I think it was Abu Dhabi or Dubai. I can’t remember which one. Canada, they have one in this opening. They still have a long runway for growth, and these results actually made me interested in not only holding, possibly even buying more at some point when I can.

Ricky Mulvey: Let’s turn to Southwest. Another big story. They reported earnings, but the bigger news is that they’re going to get rid of the boarding process where you don’t have an assigned seat. Before we dig in. Do you like having an assigned seat when you get on a flight?

Sanmeet Deo: I like having an assigned seat. I think traveling is stressful as it is, enough to worry about as it is. When you have kids, you’re managing them. The last thing I want to worry about is having to get on board the plane and fight for a seat from somebody and then have more issues. I like the comfort and the convenience of knowing, this is my seat, this is where I’m going to sit.

Ricky Mulvey: Maybe it’s because I don’t have kids. I like the action. There’s some weird social dynamics going on. You really got to lock it when you get on a Southwest flight, especially I’m a want to get away flier, so I’m back in C and you got to make some reads as soon as you get on. Anyway, Southwest reported earnings this morning, big news CEO Bob Jordan says, the airline, now I’m quoting, “taking urgent and deliberate steps to mitigate near term revenue challenges”. The big news on that is implementing assigned and premium seating. I know you don’t like the open seating, but what do you think of this sudden move by Southwest?

Sanmeet Deo: I don’t think it’s that bad of an idea. I don’t really see customers as being so gung ho about Southwest having, like, open seating that they would just move away from the company and not use them for flights. But I think it also helps to expand their revenue in terms of their seats and taking advantage of different locations, different pricing, and help their revenue and create some more demand there.

Ricky Mulvey: What Southwest is responding to a couple of things. One is Elliott Management, which has taken a big stake in the company, although you know what, CEO Bob Jordan on CNBC saying that this move has nothing to do with the activist shareholders. Absolutely nothing to do with them. But its profit is down almost 50%. What’s happened at this airline that created this problem?

Sanmeet Deo: I think their revenues are generally OK. All airlines, from the little I know about them, have just faced increased costs when it comes to fuel, labor, planes, issues with planes, like Boeing, not getting deliveries of those planes. Tons and tons of issue. I can’t imagine how difficult it must be to manage an airline business. They need to do whatever they need to do to get their profits going again. There have been a lot of airlines that have been profitable because they’ve done all kinds of things like premium sitting and charging for bags and charging for God knows what. It’s probably overboard. Customers don’t love it, but it’s helping the businesses. The CEO Bob Jordan is on the hot seat. While he says, Elliot has nothing to do with it. Clearly, they have something to do with it. Also, clearly, Elliot’s calling for him and the chairman Kelleher to be booted and Kelleher is a founder, so that’s big time. A lot of pressure.

Ricky Mulvey: They’re making some moves, including seats with extra leg room, adding overnight flights, and they’re facing pressures, as you mentioned, with Boeing not delivering the planes that they have ordered from them. When you look at these moves from assigned seating, adding overnight flights, do you think these are going to be enough to appease the wolves over at Elliott Management, which has a $2 billion stake in the company?

Sanmeet Deo: If they’re able to generate some profits from it, then then maybe they will, but I think they’re going to keep drilling into them, for sure.

Ricky Mulvey: Final question. They’ve taken away the seats. Do you think that free bags are next on the cutting room floor for Southwest Airlines?

Sanmeet Deo: I don’t think so a big part of their promotions is bags fly free. They’re the only US carrier that doesn’t impose fees to check two bags. The CEO has said they won’t charge for checked bags, and they’re not contemplating change. It’s actually a pretty important point for customers. I know I would be very hesitant to fly if they’re charging me bags.

Ricky Mulvey: We’ll see what happens. Sanmeet Deo, appreciate your time and your insight on this.

Sanmeet Deo: Thanks, Ricky.

Ricky Mulvey: Up next, Asit Sharma joins me to take a look at one of Warren Buffett’s favorite investing metrics. Asit, something our CEO co-founder Tom Gardner discussed at Fool Fest was this metric that I really hadn’t looked into before, and I wanted to get to the bottom of it more with you. It’s called ROUNTA which is Return on unleveraged net tangible assets. How’s that for a word salad? Here’s why you should pay attention, though, because this is said to be one of Warren Buffett’s favorite metrics. I’m struggling. Where do we start breaking this down? Should we start with the net tangible assets part? Because I want to understand what Buffett’s looking at, but I want to be able to get this in a clear way.

Asit Sharma: I think we can start there. Some of our listeners will be familiar with a term called RONTA, which is return on net tangible assets, which is conceptually easier to understand. When I start thinking about RONTA, in my head, a song comes to mind. Help me Ronta. Help, help me Ronta. Here we go. Let’s start with the net tangible assets space. I think that’s pretty easy to understand. When you are a publicly traded company or when you’re a private company, you’re going to have hard assets on your books. Think cash, think receivables, inventory and fixed assets, then you’re going to have some intangible assets on your books. Maybe you acquired a company which had some intellectual property, and you paid more for the intellectual property versus the hard assets on the books. Accounting forces you to put the value of the intangibles you acquired on your own balance sheet in the form of goodwill. You can also acquire intangible assets in other ways. You can even develop them in house. When we think about the asset world in accounting and translate that to business, there’s always a tension certain investors want to focus on the hard assets that are returning that economic value, and accounting standards and other investors want to focus on everything, the whole soup, whether the assets intangible or tangible. Net tangible assets means we exclude goodwill, other things like intellectual property. Just look at those hard assets that I was talking about before.

Ricky Mulvey: It’s a more concrete way of getting an asset base for a company, which if you have Disney and you think about the trademarks and intellectual property they may have could be an issue, but generally, we’re talking about rules of thumb here. The second thing that this gets rid of is the debt. When we get to this return number, why are we getting debt out of this thing?

Asit Sharma: Let’s now extend net tangible assets by one letter, unlevered net tangible assets and that is getting rid of the debt. If you’re actually performing this calculation, you’re adding debt back to the equation. Why is that? Conceptually, Warren Buffett thinks that companies shouldn’t necessarily be penalized for having a lot of debt, because his focus is on the assets on the top of the balance sheet that are making the money. Sometimes companies borrow quite a bit of money to acquire intangible assets or to make an acquisition where they’ve got goodwill. In Buffett’s mind, this goes back to how we should think about intangibles. Accounting treatment says you should start amortizing those every year. You should wind the value down by a certain amount each year. Buffett says, no, they contribute economic value to the balance sheet. You could just sort of ignore them. Let’s think about Disney. Disney has all this intellectual property, so it’s recorded that somewhere on its balance sheet. But what’s really driving the returns is the combination of the brand, the intellectual property, and the cash on its balance sheet, the theme parks, the cruise ships, hard assets. Buffett likes to think in those terms, I get that intellectual property piece, I get the IP piece, I get the goodwill, but I want to see what those physical assets are returning. That starts to make sense to even a lay investor.

Ricky Mulvey: We’re putting the return on top of this thing. We’re looking at the net income basically on top of these hard assets. What is this number? What does this whole thing tell investors about a company?

Asit Sharma: It’s pretty simple. Let’s think about net income. That’s easily understood by every investor. It’s the money leftover at the end of the year after a company has pulled in its revenue and paid all its expenses out. There’s one little tweak here. Buffett says, that amortization piece, that non cash theoretical charge against earnings that we each year push against total assets, we should ignore that. We’re talking about real returns. You remove amortization from net income, and that’s the top of your equation. That’s your return piece. On the bottom, you’re thinking about those net tangible assets. If you’ve got debt, add that back, so you’re focused as an equity base on the stuff that’s producing the real world economic returns, and that’s the gist of how we conceptualize this. In theory, it’s pretty simple, but surprisingly, Ricky, it’s obscure. Now, as you pointed out, our CEO Tom Gardner has alighted on this as a metric he’s looking very closely at for those listeners who might have attended Fool Fest. You heard him talk about this. If you go out on the web and try to find out all about ROUNTA, R-O-U-N-T-A, there’s not much written on it, and here’s the reason. Warren Buffett has never clearly defined what he means by ROUNTA. The Investment community has backward engineer this and pieced together what he means.

Ricky Mulvey: I went through our in-house AI model to get an Excel formula to find this thing. Is there an easier way to find this? Where am I supposed to go looking for this Asit?

Asit Sharma: There are a couple of articles that if you read through them, will summarize this conceptually for you. But they’re tense reading also.You could go to Warren Buffett shareholder letters over the years, and there are certain years in which he crystallizes the concept. But I’ll say this. It’s a lot like return on invested capital. There actually is no single definition for ROIC. Although people talk about ROIC all the time, like, it’s crystal clear. It’s not. If you talk to one investor, he or she might have a slightly different version of that than another investor. I think it’s going to be one of these things. If more people look into it and use it, that accepted and conceptual, just the way you and I have talked about it rather than here’s the specific formula. This is the way you always calculate it. I have my way of calculating it. I’m sure you have your way. The AI probably has a way to each his own, as long as conceptually, we arrive at the same place.

Ricky Mulvey: My way of calculating it is very closely aligned with the AI’s way of calculating it, Asit. For listeners, there was one change where I had the interest expense. Asit had the amortization and so we got in the same ballpark for most of the companies. But as we’re talking about ballparks, we’ve just described this complex metric for a company that says, what they’re returning on their hard assets? What’s a good ROUNTA? We do all this stuff. It pops out a number. What’s a good one? I got 40% for Lululemon and just 11% for your beloved AMD, NVIDIA is really high. My measure was 97%, but I’ve seen metrics that are way way higher than that.

Asit Sharma: I think it’s a great question. First of all, we may have to make a differentiation between pre-tax and after tax ROUNTA.

Ricky Mulvey: This is fun. Are you having fun, Asit?

Asit Sharma: I’m having so much fun. I know I’ve got to raise my voice. I just got a visual cue from you as we’re recording on Zoom to raise my voice so we wake some people up here at the halfway mark. But I’m actually enjoying this conversation so much. Let’s think about that. Actually, we won’t. Just assume it’s all after tax. A good after tax number is ballpark where Lulu is, I would say 30% and above, you start to get a sense a company is doing something really nice with its assets. Now, we should point out, we were just chatting before we taped. Lululemon actually doesn’t have any long term debt, and he don’t have much of anything in the way of intangible assets. When you crunch their normal net profit margins or operating income versus ROUNTA, the numbers aren’t that all different. But it says something about Lululemon. It’s a highly profitable company with a great brand. Their stuff is pricey, so they bring home a lot of money at the end of the year. I do want to come back at you on AMD, but you may have a question or an interjection first.

Ricky Mulvey: Just 11%. On my calculation, I just got 11% for your beloved AMD. You’re big fan of AMD. You’re upset in the CEO draft when my team got Lisa Su and yet they have such a low ROUNTA. Do you take that personally?

Asit Sharma: No, I take it in context, Ricky. Here’s a thing. Like any one metric that you look at, whether it’s some investor talk about the price to earnings growth ratio. Others are focused on Ford manifestations of free cash flow. Everything in context. AMD actually, over the last year, was at the bottom of its cycle in all the businesses that it operates in, which is a wide part of the semiconductor industry. You can look back two years and three years ago, and it would have a much higher round to score. Now, I’m going to take a little issue with your calculation. I’m just going to read these numbers out for anyone who still might be awake and happens to be interested in this stuff to show you my derivation real quick. Sixty eight billion total assets. You’re going to take out the intangible assets of 45 billion gets you to 23 billion in adjusted total assets. You’re going to take out $11.7 billion in liability, add back 1.7 of long term debt. Your base is $13.4 billion. Now, I know no one listened to that. But just to make a point, if anyone has a calculator in hand, when you take the last year of earnings for AMD and add back some amortization expenses, not more. You actually get $3.6 billion. They have a large amortization component on their books. Actually, I misspoke. That leads you to a 27% return on unlevered net tangible assets for the last year. You go back two years, and it’s way higher. AMD is doing all right. NVIDIA is really the one that stands out. Just super high, and we can check about that.

Ricky Mulvey: I know you can’t see this, but Asit, when he’s doing his numbers, his face shifts. He’s going hard in the paint at that point. The blockbuster is NVIDIA. I got 90% or more than 90%. I’ve seen it way higher. Regardless of the calculations we got, NVIDIA’s ROUNTA is way higher than AMD. It’s one of its direct competitors. What story does that tell you about NVIDIA?

Asit Sharma: Well, first, Ricky, it tells me that NVIDIA has amazing pricing power. This is a company that really burst onto the scene. We all knew about it, but with generative AI, it’s supplying GPUs at name your own price level to hungry hyperscalers and enterprise businesses. The margins have exploded. Also, it doesn’t have a lot of long term debt on its books relative to its base so that doesn’t affect the calculation much. But here’s the kicker. Why ROUNTA is even higher than you might expect. They’ve done all this without much of intangible assets versus the rest of their hard asset base. Total assets of 66 billion, goodwill of only 4.4 billion, and intangible assets of only a billion bucks. You’re talking about a company which has developed everything in house for a long period of time, and suddenly is able to capitalize on that. Every bit of cash, accounts receivables, inventory, prepaid expenses. You name it. That just has so much more of a yield versus a company that might have had to acquire all this intellectual property and take on debt to make that happen. This company’s built stuff in house, their name and their price, and so their round is through the roof.

Ricky Mulvey: Let’s wrap up with this. You went through the calculations for the people that are holding on to a calculator. For the people that aren’t holding on to a calculator as they listen to this show, are there any other financial metrics that pair nicely with this that can give investors an idea of how good a company is generating cash on its assets without maybe pulling up the Excel spreadsheet?

Asit Sharma: You named it, Ricky. Cash is so important in investment, that’s what we really value companies on. A company with a high ROUNTA score, often will have, increasing cash flows over the same time period that you calculate ROUNTA. Sometimes those though will get diminished by the fact that, as you were chatting just before the show, there’s interest expense on the debt. ROUNTA can’t give you everything. But I think looking at cash flow metrics, if you want to compare forward cash flow to a company’s enterprise value, so that common stock, market capitalization, plus the debt piece, those are not bad to pair together. But I like that theme that everything has to be taken into context. If corporations had straightforward balance sheets, and they were all the same, you wouldn’t need a world where you had to distinguish between RONTA and ROUNTA. Buffett’s great insight when he was much younger that he developed over the years, and again, has never really clearly stated in the terms, we’ve had to piece this together is that you shouldn’t penalize a company necessarily if it has a lot of debt. A lot of investors think if a company’s way leveraged, avoid that. But Buffett’s like, no. Look at what it’s doing with the other side of the balance sheet. What does that look like? That could be pretty persuasive. They could generate the cash to pay down that debt over time.

Ricky Mulvey: Asit, I appreciate your time and your insight on this. Listeners, I appreciate you making it through this. This is something I’m curious about and glad for you to be here, Asit.

Asit Sharma: Totally. Ricky, you told me we get one esoteric financial concept a year. We’ve used it up, but I’m already looking forward to 2025. It’s almost August.

Ricky Mulvey: I’ll see you next July.

Asit Sharma: See you.

Ricky Mulvey: As always, people on the program may have interests in the stocks they talk about, and the Motley Fool may have formal recommendations for or against so don’t buy or sell anything based solely on what you hear. I’m Ricky Mulvey. Thanks for listening. We’ll be back tomorrow.