MEX: Tortilla Mexican Grill
Tortilla Mexican Grill (LON:MEX)
Tortilla Mexican Grill is a small cap (market cap ~£48M) listed on the UK AIM exchange and is somewhat illiquid. The chain boasts the largest portfolio of stores across the country in its subcategory, outranking its closest competitor by a factor of 5x. As a recent IPO, and one that trades in a somewhat illiquid manner, I urge caution to those reading. These are merely my preliminary notes on the company.
The perception of British cuisine is oft boiled down to being bland, unimaginative, stodgy, or just “bad”. It lacks the tantalising spice and variety of Indian food, the precision and aesthetic of Japanese cuisine, and the vibrancy and aroma of the Mediterranian diet. I believe that what most outsiders fail to appreciate is that the UK is one of the best cultivators of worldly cuisine. Even in the small city where I reside, with a population of only ~500,000, you will find the world’s spectrum of culinary preferences represented within walking distance. As such, the nation is no stranger to burgeoning food trends. JustEat, one of Europe’s largest food-delivery companies, report that European (predominantly Italian), Chinese, Japanese, and Indian are the UK’s favourite choices when tickling their international tastebuds. I was surprised to find that, in a 2020 paper published by Deloitte, Latin American food represented just 1% of the food service market share. But there are signs that consumer appetites for LatAm are trickling upward. Having grown at a rate of ~1.5% per annum over the last five years, the UK foodservice market is estimated to be worth ~£20.6B. Over the same period, LatAm cuisine outpaced the broader industry by a ~5.5% annualised surplus.
This is a trend that PwC believe will continue, citing that the market for Mexican cuisine in the UK is set to compound at ~8% from 2022 onwards on the back of strong consumer sentiment. Whilst LatAm sits in the lower rungs of the cuisine rankings, it represents ~10% of the total market for our American cousins across the pond. In the UK however, the number of Tortilla outlets is minuscule when compared to the leaders of mature categories like coffee, pastry, and American fast food.
Chipotle, a company with over 3,000 stores worldwide, most of which are located in the United States, is a shining example of the uptake in this quick-serve Mexican value proposition. Fast food with fresh, customisable, ingredients and great taste has resonated with the American consumer. However, Chipotle’s success has not translated overseas, but more on that later. Whilst many American consumers baulk at the prices of Chipotle, the top dog in the Burrito business in the UK is known for having some of the lowest prices in the market and operates an otherwise identical value proposition to Chipotle. Tortilla Mexican Grill is that top dog of which I speak. However, the market in the UK is infantile compared to the States.
Despite its title as the largest Mexican chain in the country, Tortilla only operates 68 stores (plus an additional 8 franchised stores) across the nation. Even so, Tortilla is larger than the combined store count of its closest four competitors. Whatsmore, as the restaurant industry was hammered during covid, many of Tortilla’s competitors were forced into administration and/or forced to become leaner, reducing store count and overheads. Tortilla, on the other hand, thrived. The company opened an additional 10 stores between 2020 and 2021 and despite a YoY decline in revenues in 2020, ended 2021 with revenues sitting 36% higher than they were in 2019. The company represents a capital-light, scalable franchise, with an attractive lead in the market. Moreover, the management team has a history of wielding capital effectively, a factor which allowed them to get ahead of the competition in the formative years of the (later dubbed) Burrito Wars of the mid-2000s; more on that later.
After gaining the consumer’s attention (& wallet share) during covid, a feat which was enabled through management’s steadfast pivot to delivery, the current question on Tortilla is whether or not they can retain those mindshare gains going forward. The earliest evidence points to ‘yes’, but there’s more to unpack. Before we even begin, it begs asking, is the offering actually good? Naturally, I had to conduct the most serious of investigations into these claims, ordering both delivery and visiting one of their maiden mall-concept stores. I made sure to repeat the process multiple times, to ensure a fair sampling process.
As a fan of the cuisine myself, having previously been a frequenter of rivals Wahaca and Barburrito, I can attest the food is of high quality (relative to peers), and the price point was noticeably more attractive. In particular, the burrito, which feels like the best value for money option on the menu. The tacos, (both corn and tortilla shell) were equally as good but a touch more expensive per calorie. A lack of quesadillas (a personal favourite) was noticeable, but then again there are peers that don’t offer tacos. All in all, I wouldn’t question whether Tortilla Mexican Grill is a standout winner with respect to its menu. The dominant players in this market sell fairly commoditised offerings, with their weapons of choice being branding, proximity, and subtle menu variation. But one area that Tortilla does come out on top in price, without sacrificing quality. I believe they are strong enough to compete with the likes of Chipotle, Barburrito, and Wahaca. With that established, let’s dig in.
The memo will flow through the following segments.
• The Basics of Tortilla: Starting with a brief insight into the history of the company, before highlighting the core operations and business model of the business.
• Financial Highlights: A cursory glance at the financial position of the company, as well as an assessment of ownership and management.
• The Market Landscape: An overview of the UK market, as well as Tortilla’s primary competitors, competitive advantages, and M&A activity.
• Red Flags, Bear Case et al: Commentary on perceived risks, red flags, and the bear case.
• Conclusion: Thoughts on valuation, and concluding remarks.
The Basics of Tortilla: History
Tortilla Mexican Grill, formerly Mexican Grill Ltd, was founded by Brandon Stephens in 2007. Upon arrival in London in 2003 Brandon, originally hailing from the Burrito county of California, identified a gap in the market for quality fast-serve Mexican outlets after failing to satisfy his Californian urges for the cuisine (as a side note, this is the same backstory that mostly every UK-based competitor preaches). Tortilla was established with a mission of offering customers freshly prepared, customisable, and authentic Californian-inspired Mexican food. This was actually a novel concept to Britons at the time. Today, British consumer awareness of Mexican food is strong. Statista, the data company, reports that 96% of British households are aware of what a burrito is. However, back in the mid-2000s, there was a knowledge hurdle to overcome.
In an interview with Big Hospitality Brandon would remark that “there was a lot of education required” upon their entry to the market in 2007, alongside newly founded Barburrito (2005) and competitors like Chilango (2007) and Wahaca (2007). As Mexican food began to grow in popularity, this period was dubbed the “burrito wars” by UK media in their coverage of several seemingly homogenous brands vying for the top spot. A decade later, Tortilla managed to rise to the top, growing its store count faster than anyone else, despite the addition of well-capitalised players like Chipotle in 2010. Superior access to capital was the ingredient that seemed to catalyse their top spot, with the company raising £3.5M from US private equity firm Quilvest in 2013, before raising a further £2.5M in financing from Santander. Having access to that level of capital early on allowed Tortilla to “take premium sites in the right places [and] put a central production kitchen in place early on, which immediately gave us a consistent product across the estate” according to, now CEO, Richard Morris.
By 2014 Tortilla had 21 stores nationwide, but Brandon had taken Tortilla as far as he could, realising that he was “not necessarily the person with the skillset to take it to the next stage” according to Morris. In came Richard Morris that year, taking the role of managing director. At the time of his arrival, Richard was a 20-year veteran, having served as the director of operations for brands like TGI Fridays, Rainforest Cafe, and a 10-year stint at Loch Fyne Seafood & Grill where he graduated from operations to a managing director role. At Loch Fyne, Richard was part of a team that executed a buyout of the business, which had 2 stores, for £150,000 in 1998. After scaling the business to over 39 stores by 2008, it was eventually bought out by Greene King for ~£68M. More lavish details on Richard’s evolution of Loch Fyne can be found in this great write-up composed by Shortavocado in the Value Investors Club. The point I wanted to make here, is that he had the credentials to take Tortilla to the next phase. Following Richard’s admission to the top spot at Tortilla, Brandon Stephens would take a seat on the board of directors, where he remains today. Today, both Richard (3.57%) and Brandon (8.3%) own ~11.9% of the company.
Immediately upon taking charge, Richard would implement key changes to the business. He brought in people to examine the supply chain and consolidated the number of suppliers Tortilla relied on from hundreds of small locals to a handful of larger ones. Thus allowing for the benefit of economies of scale now that Tortilla was buying their inputs in greater volume, which brought the cost of food and drinks down, and improved margins. After Tortilla launched its first digital offering in 2010, Morris would embrace delivery further by partnering with one of the nation’s largest food-delivery companies, Deliveroo in 2015, in a deal which would see Tortilla exchange exclusivity in return for favourable commission rates on the platform. Back in 2018, Morris would remark that Tortilla was early to embrace delivery services like Deliveroo despite the early scepticism from peers, touting the increased output, consumer awareness and diminished reliance on capital expenditure as being the primary impetus to their decision.
“We’ve embraced Deliveroo and delivery generally. A lot of businesses have tried to push against it. We know that people want to have restaurant food in their own homes and dining rooms. Delivery costs eat away at our profit margins, because you’ve got to pay for them to deliver the food. But because our costs going into these businesses are lower – we’re paying less rent and less capital expenditure because the places are smaller – it works incredibly well for us” - Richard Morris, Tortilla CEO, 2018
Sidenote: Tortilla has since remarked that delivery actually increases margins, by increasing pricing to (more than) offset the commissions paid to partners.
To cope with the additional demand, the team began to launch miniature stores in densely populated residential and office areas, designed specifically for takeaway orders. Additionally, the group began to open purpose-built cloud kitchens across the country to bulk up its supply chain whose nucleus is located in Tottenham Hale, where the company operate a 5,500-square-foot central production unit that serves all UK outlets. The flexibility in Tortilla’s supply chain, as well as their pre-established relationship with delivery ultimately allowed them to survive during the pandemic.
As in-store sales (and sales, period) crashed to a halt in March 2020, Morris’ quick pivot allowed delivery to pick up the slack as restaurants across the nation struggled with ever-changing policies on re-opening and safety for in-store dining as cases of the virus dissipated and new variants emerged. In the summer of 2022, Tortilla would break its 6-year exclusivity with Deliveroo and partner with JustEat and UberEats, as well as Deliveroo, in an attempt to “access more customers choosing to stay at home”. In light of the fact that the UK food delivery market is a three-horse race, I think it was a prudent move to back all three horses in lieu of favourable rates from Deliveroo. Adding two new partners, and losing favourable rates with the third should have an adverse effect on margins, but come with greater revenue potential. A worthwhile temporal sacrifice as the brand looks to acquire the mindshare of the UK consumer, in my opinion.
Today, the company owns 68 stores & kitchens in the UK (as of July 22’) as well as an additional 8 franchised locations through partnerships with Compass Group (4) and SSP (4). Tortilla also operates 8 franchised stores in the Middle East through a partnership with Eathos.
The board’s goal for the business is to go from “50 to 200” stores across the UK, create a national brand, and open at least 45 new company-owned units by 2026.
The Basics of Tortilla: Business Model
Tortilla Mexican Grill PLC is the outright owner of three subsidiaries; the original UK company-owned chain Mexican Grill Ltd which handles restaurant operations, Mexican Grill International Ltd which handles franchises, and California Grill Ltd which handles leases. Tortilla is the largest Mexican quick-serve chain in the UK, thrived as others suffered during covid, has a considerable self-funded reinvestment runway, and runs an asset-light operating model. The current modus operandi of the business is to prioritise unit growth and capture market share in this nascent food sub-category. An aggressive UK roll-out is the primary objective, aided by the construction of company-owned units, as well as franchise & strategic partnerships. Despite advertising itself as “the largest fast-casual Mexican chain in the UK and Europe”, the company doesn’t actually possess a presence in Europe Ex-UK. Bringing the brand to European consumers remains a “mid to longer-term” aspiration for this budding burrito joint.
Minimal verbiage is required to explain the consumer proposition of Tortilla Mexican Grill. The company is in the business of quick-serve Mexican cuisine, where ~52% of sales come from Burritos, ~26% from tacos and ~22% originates from drinks, sides, and others. Customers line up on the left side of the checkout, they migrate through the filling station (beans, cheeses, meats, salad) and are served their meal on the right-hand side. If you have been to a Chipotle or a Subway, it’s much the same set-up. Tortilla simply plays on the idea that customers can be served quickly with fresh, customisable & quality ingredients, and are not reinventing the wheel. In a market with several competitors (more on this later) offering much the same product, Tortilla stands out as the “value for money” alternative, being the most affordable brand on the market, without sacrificing quality. If you’d like to visualise what a store looks like and some of the food, you can view this quick 3-minute brand story video.
I’ll touch on this more later, but I think this is a significant proponent of Tortilla’s ability to dominate the market. The offering (largely commoditised) is not superior or materially worse than peers. But, they have a significant size advantage, are lower cost, have vastly superior margin, are well capitalised, and have a proven track record of scale and savvy capital allocation. It’s partly a battle of branding, but I feel that rapid growth of store count can be just as effective when it relates to capturing the mindshare of the UK consumer. Save for pontification about which brand is best, I believe this is mostly a scale story and a battle of proximity. Back when I was a student, my favourite Mexican joint was a spot called Pintos, later acquired by Barburrito to lay their stake in Scotland. I then began dining at Barburrito. I mourned the loss of my beloved Pintos, but at the end of the day, each chain is remarkably similar, and proximity appears to be a deciding factor when choosing where to dine.
To optimise costs, Tortilla prepares items such as meat fillings and beans off-site, at a centralised 5.5K square foot central production unit (CPU) based in Tottenham Hale, while perishable items (guacamole, salsa, toppings) are prepared in-store. The CPU allorws for cost control, consistency, and reduces the need for industrial kitchen equipment in stores (lower CapEx). Whatsmore, with fewer than 45 ingredients on their menu, and a reliance on just a handful of a few large suppliers for food, beverages, and packaging, Tortilla’s supply chain is homogenised and optimised for cost control. Further, given that it doesn’t require a degree to learn how to fold a burrito, the hiring model incurs minimal training costs.
Who Dines at Tortilla and How do they Discover the Brand?
It should come as no surprise that store expansion is Tortilla’s primary method of customer acquisition. Just over 59% of the domestic stores are located within London, but roughly half of the top 10 performing units are located outside of the city. According to a 2021 study conducted by Ann Elliot, ~74% of Tortilla’s consumers are under the age of 35, and 71% are repeat patrons. When asked what five values they most associate with Tortilla, the top 5 responses were taste (80%), freshness (57%), good value (51%), consistency (45%), and healthy food (36%). With such a youthful consumer base and hunger-inducing product, it would make sense that Tortilla’s primary social funnel is video-centric, with Instagram and TikTok allowing the brand to show off their product to an audience of users that align with their largest age cohort (Tortilla’s Facebook presence largely consists of Instagram videos shares to Facebook).
Besides their social presence, Tortilla engages with influencers (a collective 12M follower portfolio), advertises via paid social, search & display ads, collaborates with supplier brands to drive awareness, and utilises CRM within an email list of ~125K customers. Much like every branded restaurant, Tortilla also operates a loyalty program, entitling customers to earn stamps each time they dine, which can be redeemed for free meals (9x stamps = one meal), as well as a free birthday burrito, and free samples of new specials. Besides the joy of being awarded 8 stamps for signing up, the program is underwhelming. The sign-up process is restricted to the web and cumbersome, there is no app, and the rewards card exists exclusively inside Apple Wallet. The benefits of reward-member consumers are well established. Starbucks suggests rewards members frequent the store and spend ~3x more than a non-reward member. While Tortilla’s loyalty program is basic at best, I see potential with a small amount of investment. Low hanging fruit.
Store Strategy & Distribution
Distribution for Tortilla is fairly simple. The CPU in London acts as the hub for the supply chain, with enough capacity to fuel store expansion for years to come. The co-owned and franchised units act as consumer-facing vehicles for the sale of goods and brand presence. Now partnering with all three of the leading delivery companies; JustEat, Deliveroo, and UberEats, Tortilla leverages third-party delivery to cater to consumers at home. Supplementing that delivery capacity are Tortilla’s cloud kitchens (professional commercial kitchens), built exclusively to fulfil delivery orders. Tortilla has never closed a single store, even during the 2020 pandemic when many competitors were forced to downsize. With minimal kitchen equipment required, the team can afford to source smaller units (between 60 and 200 square meters) and show a preference for areas with high footfall, corner locations, 7-Day trade, and proximity to transport hubs. This tends to lend itself to high streets, shopping centres, leisure centres, transport hubs, and motorway service stations. Tortilla operates 6 cloud kitchens at present.
Dependent on the size, location, and nature of the store, each unit will cost between £350,000 and £425,000 in CapEx to construct (excluding cloud kitchens, which are considerably cheaper). Management attests that they plan to between 3-4 cloud kitchens annually, which are included in their endeavour to open 45 new company-operated units by 2026 (~9 per year). This is considerably higher than their average net new unit rate across the past two decades, but the present day supposedly harbours more fruit for the pickin’ when it comes to potential locations.
Frequently acknowledged by management, the current market in the UK is offering up a healthy stream of real estate opportunities. The esteemed Short Avocado, puts it eloquently in their write-up that was featured on Value Investors Club.
“To say that UK property owners are clamouring for commercial tenants would be an understatement. Landlords are providing significant rent reductions and, in some cases, are contributing to Tortilla’s build-out costs. In Exeter, the landlord provided a 20% rent reduction and half of Tortilla’s up-front CapEx. In Edinburgh, rent was reduced by 25% and the landlord paid for half of Tortilla’s CapEx. And in Bath, Tortilla was afforded a 10% rent reduction, 6 months rent free, and 6 months’ worth of capital contributions.”
Tortilla has a specialised property team that supports unit growth with a rigorous new site process including site selection, assessment, contract negotiation and fitting. Further, management often remarks that their ROCE threshold for new sites is 35%. Tortilla’s uncompromising unit strategy has been demonstrated in the past. After opening 8 units in 2014, and a further 11 across 2015/16, a slowdown occurred in years 2017/18 (4 units opened) with Richard Morris stating the company felt there was no value in the market at the time. The pipeline appears to be stronger in the present, with Deloitte’s 2019 Whitespace Report confirming there are ~120 additional UK sites that met the group’s selection criteria. The group are not opposed to acquiring growth either. Most recently, with their purchase of Chilango, and the 8 units that came with it. These 8 units are not included in the goal of opening 45 new units.
In tandem with building out company-operated units, Tortilla seeks franchise and partnership opportunities to broaden the reach of the brand domestically and internationally. Beginning in 2016, the team has opened 20 franchised units across the Middle East and the UK with Eathos, Compass Group, and SSP, as well as one partnership store with Merlin Entertainment.
• Compass Group (4x Units): Acting as the largest contract food service company in the world, employing ~500,000 people, Tortilla’s partnership with Compass Group appears to be largely campus-based, with 4 units located in universities (Brunel, Swansea, Middlesex and Sussex) thus far, and plans for a further 10 locations over the coming 5 years. A global monolith, Compass has a presence across 44 countries in business, healthcare, education, sport & leisure, defence & government, and offshore. A potentially strong partner for both domestic and international expansion.
• SSP (4x Units): Another food service contractor, SSP boasts 2.8K branded catering and retail units across 180 airports and 300 railway stations across 35 countries. As such, the relationship with Tortilla is largely travel-hub related. At present, Tortilla has 4 units, most recently opening in Gatwick Airport (London), Skelton Motorway Services (Leeds), and Bristol Airport. Commuting consumers in need of quick-serve dining marries well with Tortilla’s value proposition.
• Eathos (8x Units): Through a partnership with Eathos, Tortilla had 10 stores located across the UAE and Saudi Arabia at the end of 2021. To be candid, there is minimal disclosure concerning this relationship. Even more confusing, the company’s annual report (April 11th 2022) remarked there were 9 units in the Middle East. Later, during a trading update (18th July 2022) a footnote acknowledged there were only now 8 units. When first partnering in 2016, the plan was to open ~30 stores across the region. With no commentary from Tortilla, I reached out to the Investor Relations department with my query. Their response was that the lack of disclosure was due to the fact those franchises are immaterial to the business.
Considering franchise royalties are <1% of revenue, that makes sense. However, considering that between 2019-2022 the division has opened 0 and closed 2 units, my gut suggests the partnership is proving to be less successful than initially envisioned.
• Merlin Entertainment (1x unit): Opened in the summer of 2021, the maiden store sits inside the Chessington World of Adventures Resort. Operating several branded parks (Legoland, Peppa Pig World, Alton Towers) in over 140 locations across 24 nations, Merlin Entertainment has the potential to be another strong partner for Tortilla. Whilst there remains only one unit in the partnership, Morris would remark last year that “we hope to continue opening Tortilla’s of this format in more Merlin locations”.
As a precursory note, AIM-listed companies are not held to the same standards of reporting as larger cap companies in the UK. As such, disclosures are less transparent, and the cadence of reporting is less frequent. For instance, after reporting a balance sheet during the annual report in April (as of January 2022), there was no updated balance sheet in Tortilla’s July trading update. For that, we have to wait until September.
Revenue is generated through in-store sales at the time of purchase, royalties paid to the parent by Franchise partners, as well as one-time site fees upon the creation of the franchise partnership. Currently, franchise income is immaterial, accounting for 0.6% of revenue in 2021 and 0.04% in 2020. The company has boasted a ~28% revenue CAGR over the past decade during a period when the store count expanded from 7 to 64 (~25% CAGR). Last year, the company would witness a solid recovery in sales following the pandemic, reporting £48.1M in revenue. Revenue at the mid-point of 2022 is £26.9M, and with the group’s performance typically being weighted towards the back-half of the fiscal year, they are set to report revenues of between £60M to £65M in the current year.
The group has demonstrated increasing economies of scale as they have grown, expanding gross margin by ~400bps from 2011 through 2019. The notable spike in gross margin over the past two years is partly due to the dislocation in revenue composition. During 2020/21, a considerable portion of Tortilla’s sales shifted over to delivery, where the group charged slightly higher ticket prices to offset commission costs. Given that these commission costs (paid to delivery third parties) are recorded as “administrative expenses” within the operating expense basket, the expansion of gross margin in prior years is somewhat disingenuine, and I would not expect it to remain as elevated in years to come. Whatsmore, the group has received sizeable VAT benefits during this period. Some products would benefit from a 5% VAT rate (usually 20%) until September 2021, when the rate was increased to 12.5% for the remainder of the year.
And then something has to be said for the inflationary environment the industry (and the world) finds itself in. Rising input costs from inflation are bound to hit the company this year, having already taken a 4% price increase in Q1 2022. The “significant levels of cost inflation” were called out in the July trading update where management remarked that these “macro-economic headwinds are expected to persist over the coming month”. I suppose the silver lining here is that this will also be hitting peers, all of which lack the domestic economies of scale to absorb the pressure as well as Tortilla. To mitigate the pressure internally, Tortilla has taken proactive steps that include updating menu pricing, driving further operating efficiencies, and adopting the multi-platform delivery proposition (Deliveroo, JustEat, UberEats) I alluded to earlier to meet more consumers at home.
Management oft hail their ability to grow profitably, but this too is (in my opinion) slightly disingenuine, for they are referring to EBITDA (more on that in a moment) and not EBIT, where the company only showed a flash of profitability last year. At present, the bulk of Tortilla’s administrative expenses is attributable to labour costs, depreciation, and inventory, collectively totalling £30.2M (2021) and £22.8M (2020) in the prior two years. Of that, Labour was ~45% of the total. Regarding the nominal value of commissions afforded to third-party delivery providers, they don’t appear to break that out so I contacted investor relations about that too, but to no avail.
Even at that, in the last two years, Tortilla has received ~£5.37M, recorded as “other operating income” from a multitude of government schemes and grants offered to assist job retention and general hospitality sector health during the pandemic.
As such, I would be cautious about extrapolating the assumption of profitability in the near term. Particularly given that much of Tortilla’s sales leverage has originated via higher-margin delivery channels. When in-store dining levels normalise, and government hand-outs vanish, the picture will be clearer. On a positive note, Tortilla’s scale affords them a negative working capital cycle (alternatively known as a negative cash conversation cycle) meaning they collect revenue from inventory before payment to suppliers is due. An excellent quality for a restaurant to possess, allowing Tortilla to fund new stores with their own cash. Over the past 5-years, the typical cycle has been between 2.5 to 5 months (negative). Further, it’s clear that Covid-19 paradoxically became an opportunity for Tortilla by having a strong delivery product and during the lockdown periods, introducing the brand to new customers via delivery, which in turn should see them return to eat in stores.
Adjusted EBITDA (Pre-IFRS 16)
Tortilla’s preferred assessment metric of profitability is adjusted EBITDA which (amongst other things) removes the application of IFRS 16. Using this metric would see Tortilla adjusted EBITDA show profitability margins of ~7% before skyrocketing to ~18% in the most recent year. As you will note from the below reconciliation, much of this growth was afforded by sales leverage in 2021 in a year where Tortilla were profitable at the operating level (even when excluding government hand-outs).
This accounting standard requires that leases are recognised as a right-of-use asset and a corresponding liability at the date at which the leased asset is available for use. Along with the exclusion of opening costs, share option expenses, depreciation, exceptional items (such as IPO costs), and non-trading costs, Tortilla determines its EBITDA figure, and this is where they base its claims of profitability from. I suspect this is their way of demonstrating restaurant-level profitability.
In Tortilla’s regular reporting (present in the income statement, balance sheet and cash flow statement) they adopt IFRS standards. To understand the implication of IFRS 16 adjustment I would recommend footnote 27 of Tortilla’s annual report, which highlights the reconciliation between pre-IFRS 16 and post-IFRS treatment of the income statement and balance sheet. Excluding IFRS 16, Tortilla would, as an example, incur ~£3.56M less in depreciation and amortisation in 2021, a figure which is near enough offset by the inclusion of property rents. Further, the ~£1M in finance costs on lease liabilities would be excluded when not adopting IFRS 16, meaning Tortilla would come away with ~£1M additional profit before tax. If you look at the balance sheet reconciliation in the footnote, the £24.93M (2021) in right-of-use assets that sit on Tortilla’s fixed assets line item, would not be included when excluding IFRS 16.
I am not an expert in lease accounting but here is what you need to know as an investor:
Naturally, Tortilla does report its statements adhering to IFRS standards.
Management clearly disagrees with the treatment of leases, and so opts to exclude the IFRS 16 when reporting adjusted metrics.
Under IFRS 16, right-of-use lease assets are recognised as assets and liabilities for all leases with a term of more than 12 months on the balance sheet. Further, rent payments are excluded from administrative expenses, but the depreciation of right-of-use assets is included.
As one last slither of context, here is an explanation from Edmund Simms within a write-up he shared on Gym Group concerning the IFRS 16 protocol.
“But, like most companies in this space, the business model has enormous amounts of off-balance sheet leasehold debt. Well, that was until IFRS16 forced companies like this to bring them on-book. The business model works like this: 1) Sign a long-term fixed leasehold on space. 2) Kit the space out with equipment and amenities. 3) Sell a lot of short-term memberships and profit. It seems like an attractive proposition. You don’t need to own the location and the only capital you need to get going is to purchase equipment, kit the place out and advertise. Huge operational leverage, combined with enormous (pre-IFRS16) off-balance-sheet leverage means that above your break-even, every extra membership is almost pure profit and the headline returns on capital are impressive. But, the trade-off is that these large, long-term fixed leasehold commitments are, for capital financing and valuation purposes, debt. The company needs to cover them regardless of trade levels.
An almost economically equivalent scenario would be to instead of signing the leasehold for fixed yearly commitments, borrow the total present value of those commitments from a bank, pay that money to the landlord and make the interest payments on the loan. You’re purchasing, outright, the exclusive use of the commercial space. This speaks to a part of a larger, ongoing tussle between landlords and high street commercial operators to shift leaseholds from being a fixed capital expense to a variable cost of goods with turnover-based rents.” - Edmuns Simms, Valuabl
I will leave it up to the reader to determine how they’d like to treat the IFRS 16 adjustment, but I think it would be prudent to remember that leasehold commitments are debts and always have been. IFRS 16 recognised that and brought those debts onto the balance sheet and into the statements of income and cash flows. Management remarks that the average adjusted EBITDA on a store basis is ~£350K for London-based units and ~£300K for those outside of the M25.
Balance Sheet & Cash Flow
Tortilla’s net cash position as of July 2022 stands at £3.1M, which is the most up-to-date figure available in absence of a refreshed balance sheet (the last of which was reported as of January 2022, back in April). Assuming Tortilla still holds £3M in non-current borrowings (30% of a £10M revolving credit facility the company holds with Santander), then cash should be somewhere in the vicinity of £6.1M. This assumes that the company has utilised ~£3.5M in cash since the January reporting period, and has not drawn upon more debt. Given that Chilango cost £2.75M to acquire, and the transaction was said to have been all-cash, I suspect the assumption is just. As part of the group’s IPO, the group refinanced (and repaid in full) their existing borrowing with Santander, replacing it with the £10M facility that stands today, which is due to be repaid in full on September 2026.
The business is highly cash generative, benefits from a negative working capital cycle and is accordingly able to fund the new store openings from its own cash.
This has allowed Tortilla to consistently deploy CapEx well in excess of its operating cash flow in a given year. Note how in 2017/18 when the real estate market became unattractive to management, net new units slowed to 1 in the following year, flashing a glimpse of free cash flow positivity. Years 2020 through 2021 also demonstrated positivity, but for different reasons (sales leverage, sales composition, government handouts, et al).
Not a precise metric by any means (as CapEx is not exclusively derived from new unit costs) but it is interesting to witness the relationship between CapEx and net new units as the metric becomes more “expensive”. Net new units fall as the metric climbs from 0.44 to 0.6, and then further as it remains elevated at 0.72 for two years, eventually climbing to 1.35, and then new units are built once again as it comes back down to regular levels. For all intents and purposes, as great as free cash flow is, I assume a business-like Tortilla should aim to maximise the amount of operating cash flow they pour into CapEx to build new units. Free cash flows will come with time but are not a necessity for now.
That said, at Tortilla’s current burn rate, it would not surprise me to see additional use of their credit facility and/or issuance of stock.
Management & Ownership
Founder, Brandon Stephens, remains on the board today despite his departure from the CEO role in 2015 and holds an 8.3% stake in the business. Current CEO, Richard Morris, owns a 3.6% stake in the business. The remainder is owned by institutions.
Having only IPO’d last year, raising ~£5M in proceeds at a ~£70M valuation, there is not a long enough history to track any record for dilution. However, the IPO does cast some unflattering light on the management team. Of the total 15,478,333 placing shares, 82% were from existing shareholders, meaning that exiting shareholders netted ~£23M in proceeds. Moreover, Richard Morris (25%) Andy Naylor (25%) and Brandon Stephens (25%) used the IPO to unload material portions of their own ownership.
Whatsmore, the offering document remarked that the proceeds from the IPO were to be used to "accelerate its growth plans” by “accelerating the UK rollout, developing and executing on scalable franchise opportunities”. If you take the net of that £5M raised (~£2.6M) that’s only enough capital to build a number of stores I can count on one or two hands. Questionable rhetoric from management? This is a highly subjective topic, and I can’t pretend to fully understand the history of incentives for early investors and c-suite members when it comes to cashing in on a company’s success. Through one lens, it may be viewed as a canary in a coal mine. Why would investors and managers sell stock in such a promising company? Through another, it may simply be a matter of solidifying their ROI (investors) in a liquidity event or taking a well-deserved payday (for managers). I will leave it up to the reader to decide.
The management team and board appear to be of high quality, all possessing rich expertise and experience in the food sector. Emma Woods, who joined as Chairwoman in 2021, was CEO of Wagamama (~150 stores in the UK) from 2018 to 2021, prior to which she was their Chief Growth Officer. She has also served in various marketing roles across industries, such as Group Marketing Director at Pizza Express, Merlin Entertainments, and Unilever. Andy Naylor, CFO, joined in 2017 after acting as Head of Finance at Gaucho (an Argentinian chain with ~16 stores in the UK). As explained, Richard Morris’ success with Loch Fyne stands as a testament to his abilities in the sector. The remainder of the board is made up of Brandon Stephens (founder), Loeiz Lagadec (representing Quilvest interests, their largest shareholder) and Laurence Keen, who is the acting CFO of Hollywood Bowl Group, and has held senior roles in Finance across Paddy Power (gambling), Debenhams (consumer retail), Tesco (supermarket), and Pizza Hut (restaurant chain).
When it comes to compensation, both Morris and Naylor are paid conservatively. Morris’ salary of £180K per annum falls well below the £348K median salary of AIM-listed CEOs, and his total remuneration (£150K of which was a one-AIM admission bonus) of £368K is considerably lower than the median of £968K for AIM CEOs. The same can be said for Naylor’s £133K salary (£221K median) and total remuneration of £275K (£529K median).
Annual bonuses are also conservative, capped at 50% of the executives’ base salary and carry no concrete language as to how those are parsed. The same is true for the LT incentive plan (options). I don’t know what to make of the conservatism, but it's always pleasing to see executives are not grossly overpaid relative to their output.
Observing only the quantity of units across the nation, Tortilla appears to be the outright leader, operating 5x more stores than their nearest competitor and more units than the nearest 4 competitors combined. I have read commentary that suggests the competition is not worth mentioning, and whilst it does seem ignorant to say so, would have agreed with this sentiment last year. Take Barburrito for instance, Tortilla’s closest competitor. The business had 17 stores in 2015 with “plans to increase the number of sites to 25” by 2016. Seven years later, it has just 16 units. However, as I shall later detail, this is a backwards-looking perspective of the market. Today, Tortilla’s two largest competitors are now owned by groups that have sizeable resources. Nonetheless, factoring in how each competitor faired during covid is especially insightful in drawing parallels between Tortilla and competitors.
Note: Taco Bell is another well-known Mexican-inspired chain in the UK with over 100 stores. I have excluded them from this commentary because the inputs (largely frozen, and a one-way ticket to diarrhoea city) are vastly abstract from the value proposition of the above graph of businesses. As such, they are not a comparable business.
During this time, every competing business either entered administration, filed a CVA (company voluntary arrangement for insolvency), or divested a number of their stores to stay alive. In 2020 Wahaca was forced to sell a majority stake to Oacaxa Ltd, the owners of Nandos, a popular chicken chain with over 300 units in the UK. Benito’s Hat went into administration in April 2020 and today has only 4 units in London. That same winter, Barburrito had to be acquired out of administration. Even firms outside of Tortilla’s niche landed in boiling water with the likes of Pret A Manger (coffee), and Nandos (South African chicken) closing 10% and 17% of their stores, and a collective 17,500 chain store outlets (including restaurants, hospitality & leisure) closing their doors permanently in 2020 (net, 9,877) for an average of 48 closures per day across UK high street’s, shopping malls, and retail parks.
Meanwhile, Tortilla continued to open units, pay down debt, get listed on the AIM, and come out of the pandemic relatively unscathed. The relative dominance of Tortilla was evident even before the pandemic where despite showing a correlation in like-for-like sales with the broader UK restaurant industry, they often sat comfortably ahead of the market as a whole.
This led me to wonder, does Tortilla have any kind of moat? As I was conducting this initial bout of research I consumed a tweet from Pythia Capital that stated the following:
“The best evidence of a moat is a trail of competitors’ dead bodies lying in the company’s wake. Put a different way, you don’t really know how strong a moat is until it’s been tested. A lot of companies haven’t ever been tested.”
Whilst I wouldn’t be so foolish as to suggest there is a “trail of competitors’ dead bodies lying” in Tortilla’s wake, it was evident that Tortilla was one of the few companies in this space that muddled their way through covid without significant harm. Further, I would propose that a nationwide halt to consumer mobility was a worthy “test” for a restaurant business (as demonstrated by Tortilla’s in-store sales flatlining between April and June 2020). This might be an outcome of Tortilla having superior access to capital, or superior cash flows on account of their significant lead in the number of stores they operate. In a market of mostly private-backed companies, this may actually constitute a temporal moat of sorts. Their cost-leadership is another factor that can be considered with respect to a moat. Lower pricing might have been especially apparent as consumers surfed delivery apps in 2020, allowing Tortilla’s menu to be pitted directly against peers in the comfort of one’s palm. I suspect this cost-leadership also benefits Tortilla as consumers face the wrath of inflation today.
The pandemic was ultimately a short period of austerity, with residents of the UK, and companies like Tortilla, receiving a considerable amount of support from the government. But Tortilla has found, in the past, that their price leadership has helped them during longer bouts of depressed market activity. Founder, Brandon Stephens, would once remark that this low-price proposition allowed them to weather the GFC in 2008. He quipped that sales “accelerated significantly” during 2008, claiming that “there is a flight to value for money from consumers when times are tough”. Perhaps a fitting pinch of comfort when it relates to the state of the UK economy today. I don’t have the answer as to whether Tortilla has a moat with respect to pricing, but I do believe they might have had a temporal moat with respect to liquidity & capital, as well as unit economics. A quick glance across the Companies House portal (where all private-owned UK companies must report their financials) will demonstrate that each competitor has vastly inferior gross and EBITDA margins, with questionable levels of cash on hand. Whatsmore, the impact on the topline was significantly more severe during the pandemic, and the recovery considerably weaker. This ultimately led to Tortilla’s top 2 competitors being bought out throughout the last 12 months (more on that later).
However, I’d like to stress that much of this is speculation on my part, and any transitory moats related to “size” and “scale” may now be erased as I shall soon detail. But first, an elephant in the room ought to be tackled.
Why Hasn’t Chipotle Dominated?
Glancing at the list of Tortilla competitors you might notice Chipotle, a Mexican powerhouse with over 3,000 units in the States, and wonder “why isn’t Chipotle cornering this market?”. Peers like Barburrito and Wahaca have historically not had the resources to compete with Tortilla, but Chipotle is a business that registered over $7.5B in revenue in 2021, is profitable, and has ~$520M in cash as of June 2022. Contrast this with Tortilla’s ~£6M in cash. To ascertain why Chipotle’s UK presence is languishing after entering the market more than a decade ago, I dug into Chipotle’s earnings calls, as well as utilising the expert call network on AlphaSense, where I found commentary from a former Real Estate Manager and Former Director at the company.
Back in 2009, Chipotle migrated Rex Jones (former Chief Development Officer) into the role of Director of Real Estate to focus solely on international expansion. Until then, most of Chipotle’s locations were domestic aside from a handful across Canada and the UK. When asked about Chipotle’s international expansion strategy back in Q4 of 2010 John Hartung (CFO) would retort that “we don't have a timeline for when it will be meaningful to the business”. My feeling from reading past transcripts is that this was an exploratory phase. By the beginning of 2015, just 17 (<1%) of Chipotle’s stores were located internationally, with 6 of those being based in London. Three years later, just 37 (1.5%) of Chipotle’s stores were international, in an empire that consisted of some 2,400 units. At this time, during the 2018 ICR conference, management would continue to remark that “it's an opportunity for the future - but today it’s not a focus area”. Fast forward to today, and Chipotle’s international portfolio spans just 49 stores (1.6%). Scroll through any transcript over the last decade and the answer is always the same when it comes to international strategy. Something along the lines of “we are excited, it’s an opportunity for the future”. One thing that is clear, is that Chipotle has always shown a preference for its domestic operation. This was bolstered by the revelations of management post-covid where they felt they had underestimated the extent of the saturation in the States, and revitalised their domestic growth plan with a promise to expand the brand across 7,000 locations globally, and double the domestic operation with a focus on ‘Chipotlane’ drive-through units. A great write-up from Ensemble Capital on Chipotle’s digital drive-through shift can be found here.
Chipotle’s preference for domestic growth is backed up by my findings in AlphaSense, but with a touch more insight into why that might be the case (poorer unit economics overseas). A former Chipotle Director would talk about the uniformity of the supply chain in North America, from the menu, ingredients, tech, marketing, messaging, and training, stating that “you could walk into one store in Vancouver, Canada, and another in Columbia, South Carolina, and you wouldn't know the difference.” But when you go overseas, that ceases to be the case because of input sourcing, POS, relationships, and regulation.
A former Real Estate Manager for Chipotle echoed a similar sentiment, remarking that sourcing non-GMO and naturally raised products (both of which Tortilla pride itself on) is tricky, as well as the substantial costs of operation in the country. He did remark (this interview was conducted in 2022) that Chipotle is looking to re-engage the UK market, but this has been said countless times over the last decade, so I take it with a pinch of salt.
The European expansion appears to have been somewhat of a test run on account of perceived saturation in their domestic market and has never been a priority. I believe this goes some way to explaining why Chipotle has languished in the UK, and illustrates that the threat from Chipotle to Tortilla, is minimal as things stand.
The market tends to stray somewhere between monopolistic and a baby-oligopoly. I argue that the market structure is primarily monopolistic in the sense that the barriers to entry are fairly low and that there is an element of product differentiation through branding, allowing a level of price-making. However, as the industry grows, and the number of stores each business operates increases, the barriers to entry may not change, but the barriers to being successful will. Mauboussin wrote a paper in June 2022 titled “new business boom and bust”, and in the paper, he details the tendencies of markets as they are birthed in their infancy through to their maturity. Think of it as the product lifecycle, but for a market (in the paper he demonstrates using the automobile and PC markets).
If I were to hazard a guess, I would assume Tortilla’s market is in its infancy. Not quite a toddler rolling around the floor but rather one that has just learned to utilise their legs and walk. The total number of competitors is especially small if we exclude those that are stand-alone burrito joints (one unit). I can count the number of brands that operate more than 5 stores across the nation between my ten fingers. The output of the market continues to grow, outpacing that of the general UK foodservice market. The market share of competitors, despite Tortilla’s rise to dominance, has been somewhat unstable over the last decade and I suspect it jostles as competitors attempt to catch up to the leader. As for product innovation, we are talking about Burritos here, and an operating model that has been repeated countless times across coffee, burgers & fries, footlong subs, and Mexican food (already in the States). Nothing strikingly innovative in this market.
Taking a small sample (those brands with more than ~4 units across the UK), the number of entrants still outpaces that of exits, most of which are taken out by acquisition. Before I conclude this segment with a discussion of where I feel Tortilla’s strengths lie, the below a summary of the market’s most notable M&A activity over the 12 months should shed some light on just how unstable Tortilla’s competition has been as well as demonstrating how seemingly difficult it is to survive and thrive as a Mexican quick-serve business in the UK. On the flip side, it will also demonstrate how that reality is set to change in the coming years.
• Pintos (2015): Honourable mention. Pour one out for my homie, Pinto Mexican Kitchen (Pintos). Acquired by Barburrito, this allowed BB to gain a footprint in Scotland, acquiring the 5 units Pintos had placed across Edinburgh and Glasgow. With annual sales of ~£3.5M at the time, Pintos was sold for an undisclosed fee.
• Wahaca (2021): Tortilla’s second largest competitor was acquired last year by Nandos owner, Oaxaca Ltd, in a deal that valued the business at £4M. This came months after Wahaca filed for a CVA, proposing the writing off of £25M in debt. Oaxaca ended up lending capital to Wahaca, as well as injecting £5M into the business to help fuel future growth. Now backed by the man behind Nandos, a chain which did £1.1B in revenue pre-pandemic, Wahaca appears to have been scooped up in a time of crisis. No new stores have been opened since the deal closed.
• Chilango (2022): With 8 units across London, Chilango stood as one of the five largest chains in the UK. Acting quickly to acquire the struggling business for £2.75M in cash, this opportunistic roll-up afforded Tortilla both additional units as well as removing a player from the market that could have just as easily been acquired by a competitor like Barburrito or Wahaca, giving them a considerable platform for expansion. With 6 premium locations across London (+2 outside), as well as one cloud kitchen, Chilango delivered £7.3M in revenue last year with a £200,000 pre-tax profit. Chilango was previously acquired in 2020 by RDCP Group as a turnaround project after the business was forced to close 4 branches in the wake of the pandemic. The Tortilla deal would net RDCP a cool 3x return after getting Chilango “turned around and - ready for its next stage of growth”. The acquisition comes with the obvious synergies of rolling up a smaller competitor into one’s larger supply chain. Despite being slightly EBITDA negative in the current year, Chilango is set to add ~£1M in Tortilla EBITDA in 2023, for just £2.75M or a 2.75x NTM multiple.
• Barburrito (2022): In similar circumstances to Wahaca, Barburrito were acquired by The Restaurant Group (owner of Wagamama) after filing for administration, for a valuation of ~£7M. This was said to be ~4.4x EBITDA based on NTM projections. TRG’s intentions are to double the portfolio of Barburrito (32) by 2026. Considering the multiple paid (4.4x vs Chilango’s 2.75x) and the aggressive expansion plans, Barburrito’s new backers appear to mean business. Whatsmore, the group does have some experience in the Mexican market, having owned Chiquitos for some 40 years now. This will no doubt be sour grapes for BGF, which invested £3.25M into Barburrito back in 2012, only to exit during the administration process where the company was sold for £25,000. Ouch.
Whilst Wahaca and Barburrito have largely floundered over the past 3 years, with both companies now having new backers, considerable capital to deploy, and significant economies of scale across their portfolio of brands, the burrito wars could soon be hotting up once again, as Tortilla face fresh competition from old faces. If prompted, I would assert that Barburrito appears to be the largest threat. The stores bear the closest likeness to Tortilla, operating the classic ‘left to right’ counter serving style, as well as being optimised for delivery. Wahaca, as great as the food may be, is more a traditional “restaurant” where customers sit down and order from a waiter. Whatsmore, Barburrito’s new owners have far greater resources at hand.
Last Thoughts on Competitive Positioning
I waffle a lot, so here are my succinct thoughts on Tortilla’s competitive position.
Competition: As summarised in the previous passage, the competitive rivalry has been weak in recent years as firms struggled during the pandemic, allowing Tortilla to take a significant lead. Today, that rivalry is set to heat up, with several competitors now rescued from administration with new, well-experienced and capitalised, backers. Nonetheless, Tortilla will still take some catching.
Threat of new entrants: I believe Tortilla is so far ahead that the literal threat from any one new entrant is minimal. Whilst the barriers to entry are low, I believe the barriers to success will only increase as the market share continues to consolidate. They should be most concerned with existing players.
Substitutes: As with any food-based business, there are endless numbers of substitutes. I believe the largest threat here is that Mexican cuisine proves not to be as popular as it is in the States. Thus far, the industry is growing in excess of the broader foodservice market. Tortilla now only relies on a handful of high-quality suppliers, bringing economies of scale. Further, in a world of price sensitivity, Tortilla delivers the lower-priced offering amongst peers, with no sacrifice in quality. Switching costs will always be low in this market, and I feel that price, branding, and proximity are the keys to success here.
Competitive Advantages: I can’t be sure if Tortilla has any long-lasting competitive advantages, but I do feel that they demonstrate a number of temporal advantages that may lead to the cementation of long-term advantages in the future. I believe that Tortilla’s pricing and economies of scale are currently unmatched in the market. I also feel that the depth of their portfolio adds to the proximity advantage, having stores up and down the country, whilst most worthwhile competitors are largely based in London (with the exception of a handful of stores). Lastly, assuming no reduction in quality with scale nor any major loss of brand image, I feel that a huge factor in Tortilla’s success is simply expanding at a pace well above that of peers. They have a proven quality product, at a superior price point. The brand now has to incept the mindshare and loyalty of the British public before their peers.
Red Flags, Bear Case et al
Aside from the more obvious execution risks and ailments that affect all restaurant businesses, below are a handful of the near-term risks that are specific to Tortilla Mexican Grill. Note, that the sourcing of attractive real estate for new locations is considered to be an obvious execution risk, that all peers in the space face.
• Competition Has New Life: If I had scribbled this memo 12 months ago, this point would be an omission, as the environment at that time would see Tortilla’s closest rivals stuttering under administration. Today, however, Barburrito is backed by TRG, a conglomerate that generated £636M in revenue last year through their collection of brands like Wagamama, Frankie & Benny’s, and Chiquito. Wahaca’s new owner is considerably smaller but has offered the struggling restaurant an out to administration. Tortilla has been able to capitalise during this tumulous period for peers, but the competitive landscape looks set to heat up in the coming years.
• Auditor Change Post-IPO: Less than 12 months following Tortilla’s IPO their auditor, Blick Rothenberg, would resign. This initially raised a red flag for me. As required by section 519 of the Companies Act 2006, Blick Rothenberg issued a statement confirming “there are no circumstances in connection with its resignation as auditor that should be brought to the attention of members or creditors of the Company.” Upon further inspection, this appears to be a nothingburger and was premeditated. As demonstrated by the below passage, found in Tortilla’s annual report.
“Philip Vipond has been the external audit partner for the Group for ten years (including this year’s audit). In accordance with the Ethical Standards for auditors, and Blick Rothenberg’s own policy, Phil Vipond is stepping down from the audit. The Board consider this to be the natural opportunity to appoint a larger audit firm with greater expertise and experience of auditing public listed companies and, on the recommendation of the Audit Committee and the CFO, has decided to put the Group’s statutory audit for the 2022 Financial Year out to competitive tender. This process has commenced and is expected to complete by the end of Q2 2022. The Audit Committee has therefore recommended to the Board that Blick Rothenberg be reappointed at the 2022 AGM to continue the role until the appointment of new auditors.”
That satisfied my earlier fears.
• Don’t Extrapolate Profitability: As noted in the Financial Highlights segment, Tortilla has been the recipient of significant sums of government support, grossing ~£5.4M between 2020-21. Without it, net income margins would have been razor thin in 2021, and the group would have lost considerably more in 2020. In an environment where input costs are rising, and fixed expenditure is growing as Tortilla scales, I would be hesitant to project today’s profitability forward.
• Lease Renewals Ahead: As of January 2022 ~32% of Tortilla’s leases are due to be renewed within the next 12-24 months. Consider that during 2020-21, a period in which Tortilla’s gross margin increased from 74.3% (2019) to 79.6% (2021), the group received rent concessions, government grants and VAT benefits, and factor in some modest rental increases, then it wouldn’t be hard to imagine how the group’s gross margin may depress over the coming ~2 years.
I am not a self-proclaimed real estate expert, but I would imagine (and assume so as a matter of conservatism) that now that covid is over, landlords begin to increase rents, or at the minimum remove concessions, and Tortilla’s gross margins float back down to pre-covid levels, or thereabouts. I suspect the gradual rebalance of in-store and delivery consumption will exacerbate this trend.
• Low Liquidity & Exodus of Shareholders: Tortilla’s stock is fairly illiquid, with several trading days witnessing fewer than 100 notional shares exchange hands. From the date of IPO to the 2nd of August 2022, the average notional daily volume has been ~34.6K shares. But as you can see (below) the standard deviation of those daily trading volumes, is wide. If you enjoy the fruits of liquidity and tight bid/ask spreads, then this probably isn’t a stock for you.
At present, ~75% of Tortilla’s shares are not publicly held, with a large composition of private equity backers. Quilvest, Canaccord Genuity, and Quantum Partners, for instance, make up ~45% of the share ownership table. As discussed in the Management & Ownership segment, a sizeable number of existing shareholders (~£28M) utilised the IPO to exit or reduce their exposure to Tortilla. Even key C-suite members got in on the action. Whatsmore, many of the existing PE shareholders have been with the company for a considerable amount of time. If someone like Quilvest (20.4% ownership) decided to liquidate their position then that could be detrimental to Tortilla’s share price. Regardless of whether they decided to act with a lack of courtesy (an abrupt sale) or draw the sale out over a lengthy stretch of time, the selling pressure would likely be immense. As I already concluded in that prior segment, I am no expert on the incentives of private investors. Solidifying an ROI after a lengthy period of illiquidity in a private business seems just. Whatsmore, the price action over post-IPO has validated that decision, for now.
• Franchising is Mostly a Narrative: As somewhat of a restaurant enthusiast, I do enjoy it when genuinely scalable brands decide to adopt franchising over a staunch company-operated-only mandate. As much as I applaud Tortilla’s franchise strategy, it’s an immaterial component of the business today (albeit a relatively capital-light one). I could waffle about the pros and cons of franchising like a college textbook, but make no mistake, the company-operated stores are the bread and butter here.
Lastly, I will draw to a risk cited by Short Avocado in that VIC write-up in March of 2022, where they remarked that “there is a perception that Tortilla is a subpar business that got a one-time bump in business from COVID” before concluding that “based on sales performance in periods where lockdowns were lifted, we think this concern is invalid”. I believe the continued demonstration of sales momentum post-pandemic and post-March strengthens that conclusion.
From the day of the IPO, Tortilla’s market cap has steadily unwinded (~36%) from highs of ~£75M to the ~£48M where it traded on August 2nd 2022. Much can be said for the current valuation, but ignoring the “flows” could be a costly omission. Retail holders of Tortilla stock are essentially sitting under an anvil, whose movement (rather, thrust with which it is pushed off the cliff onto the unsuspecting victim) is dictated by that of the large, pre-existing private equity backers. When they decide they want to sell, wear a helmet, or maybe three.
A full-sized unit will cost between £350K to £425K to build, plus an additional ~£25K or so in pre-opening costs. Past management commentary has suggested that monthly break-even levels can be attained within months of opening, and maturity (profitability, and average unit volumes consistent with the portfolio average) within one to two years. That’s not a terrible payback period. I suspect that a typical store will generate £950K-£1M in annual revenue once fully mature (open longer than 12 months). Whatsmore, looking back at historical financials I attempted to gauge an estimated restaurant-level EBIT figure by stripping out corporate salaries, director remuneration, non-recurring items, and auditor fees and found that restaurants are typically showing unit-level profitability in the low to mid-10s.
A relative valuation for Tortilla was tough to muster, on account of the majority of their true peers being privately owned and minimal occurrences of M&A from which to take precedent from. Most recent bouts of M&A have been obscured by the fact they took place at the heights of a pandemic. Further, the last two years of results appear to be considerably warped on account of the myriad of reasons outlined in this memo. Alternatively, I would direct readers over to that VIC write-up I alluded to earlier. The author does some great work with respect to projecting each individual aspect of the business that can be adjusted for the present day. As for me, I am still in the exploratory phase of understanding Tortilla and so don’t have any great insight into whether or not it’s attractively priced. This is usually the last step in my process, after gaining a rudimentary understanding of where the business stands in the marketplace. So, in short, I don’t know.
As things stand, I still have questions regarding how Tortilla intend to bring down administrative expenses as they scale. Gross margins have organically expanded (pre-pandemic) but this has yet to filter down into economies of scale with respect to operating expenses. Sadly, due to lack of disclosure, I lack the granularity of observation here. It would mostly be a guessing game. As Tortilla battles with rising input costs and relaxation of delivery-enabled revenue streams, I can only imagine gross margin comes down from here, but during a time when the administrative expenditure no doubt increases on account of the increasing number of units in their portfolio.
As you can see from the history of YoY growth in each component, they have often been joined at the hip. The only notable occurrence of non-pandemic performance where Tortilla flashed profitability was in 2018, a year in which the group added just 1 new unit to the portfolio. Further, the deviations shown between 2020-21 are pandemic-induced.
Using a crudely constructed table (below) for the purposes of illustration only, one can envision how positive it would be for Tortilla to bring administrative expenditure back down to pre-pandemic levels (where the 9Y trailing average was ~73.5%). This would muster up some EBIT margin, even in the face of gross margin compression.
In any event, I feel it unlikely that Tortilla is reporting anything other than razor-thin operating profit (or losses) for the foreseeable future. Moreover, if you are conservative with EBITDA projections and assume this is a business not worth any more than, say 5x EBITDA, then the upside from a 12.5% EBITDA margin 5-years from now is not impressive. But the prospect of their expansion, their efficient cash conversion cycle, their ability to generate operating cash flows, and the fact they are clear leaders in the burrito wars have interested me enough to take an immaterial position for tracking purposes. Even if I were to assume that Tortilla fails to deliver on its goal of 45 new units (let’s say they open only 5 units per annum between 2023-26) then that still leads to ~£83M in revenues (12% CAGR) with about £62M in gross profit (10% CAGR) by 2026. In short, the business itself has got me interested enough to spend some time tracking the company and attempting to understand the valuation further. I don’t mind throwing an immaterial amount of capital at an idea that could potentially operate hundreds of units in decades to come. By the same token, I don’t mind losing an immaterial amount of capital on an idea that takes the more likely route of becoming another bang-average franchise. This isn’t the most efficient of uses for capital, some might say, but it’s my capital.
Interim (half-year) results can be expected, in full, in September. I will likely revisit this write-up around then, with a more complete commentary around perceived value.
Lastly, there were a number of great resources that assisted in the curation of this memo, in particular the Value Investors Club write-up. After being sent this write-up by an acquaintance a few months ago, it perked my interest and led to me researching the company further. That particular memo is a touch more technical than mine, and so I would highly recommend reading it. The rest of the sources can also be found below. I hope someone finds these notes useful, and if anyone has superior insight into the business, please reach out, as I am keen to strengthen my understanding.
Thank you for reading,
A list of the most useful resources, besides the company’s filings, that assisted with this memo.
• Value Investors Club: Tortilla Mexican Grill Write-up
• Big Hospitality: Interview w/ Brandon Stephens & Richard Morris
• CityAM: Interview w/ Richard Morris
• BDO: AIM Director Pay Report
• Big Hospitality: How Tortilla Won the Burrito Wars
• Big Hospitality: Article from 2012
• Paul Charity: Barburrito Acquisition