Is Tortilla's offering to investors really that tasty?

Tortilla is the AIM-listed, UK-based burrito business, with roots in Californian-inspired Mexican dining. It was founded by Brandon Stephens, a California-native, with its first store opening in Islington, London in 2007 after Stephens moved to London and found it difficult to find a quality burrito and taco offering.


Tortilla wasn’t the first burrito fast-casual restaurant in the UK, with Barburrito opening in Manchester in 2005. With competition from other Latin-American fast-casual offerings, such as Barburitto and Chilango, as well as competition from the likes of Pret A Manger, Leon, and Itsu, does Tortilla have what it takes to succeed in this sector?


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Business Model


Tortilla exists within the UK's fast-casual dining sector, offering burritos, tacos, and salads that are fully customisable. Tortilla operates through a variety of channels, including dine-in, takeaway, self-service kiosks, delivery and click-and-collect. The Group has 62 sites worldwide, comprising 50 sites in the UK (leased locations operated by the Group), 2 sites franchised to SSP in the UK and 10 franchised sites in the Middle East. Tortilla also operates a 5,500 square foot CPU in Tottenham, which provides a central kitchen infrastructure.


Tortilla operates in a variety of locations, including high streets, retail shopping centres, residential/suburban locations and transport hubs across the UK. Tortilla has recently opened smaller sites, called Baby Tortillas, in addition to cloud-kitchens. Tortilla chooses its sites in high footfall locations in order to appeal to and capitalise on the impulsive nature of its repeat customer base (most of their customers are acquired from impromptu impulse visits).


The Group generally targets locations ranging from 60 square metres to 200 square metres, with the exception of its cloud-kitchen sites. The estimated capital expenditure per site (again excluding cloud kitchens) ranges from £350,000 to £425,000 depending on the size of the units, site conditions and store front requirements. The Group has a 35% minimum target investment hurdle for its ROCE (Return On Capital Employed).


Recent Performance


The hospitality sector has been one of the hardest hit during the Covid-19 pandemic. Total sales across the restaurant industry between April 2020 and March 2021 were down by 64%, falling from £126.8 billion over the previous 12-month period to £46 billion.


Despite these figures, Tortilla was able to hold its own, outpacing the Coffer Peach Business Tracker (commonly seen as the benchmark index for the UK hospitality sector's growth) by an average of 46 percentage points in the twelve months from June 2020 to June 2021.


The table shows Tortilla's like for like sales growth or decline versus 2019 in April 2021, May 2021, June 2021, July 2021 and August 2021 compared to the Coffer Peach Business Tracker's like for like growth in April 2021, May 2021, June 2021, July 2021 and August 2021 compared to 2019. From April 2021 to August 2021, Tortilla had >25% growth compared to 2019, while the Coffer Peach Business Tracker declined by 30% in April 2021, around 5% in May 2021, and then had slow levels of growth in June 2021, July 2021 and August 2021, with all figures under 10%.
Source: Tortilla's IPO Admissions Document

This performance was explained in Tortilla's IPO Admissions document as due to the adaptability of Tortilla's business, with the Group able to adjust their operating model to adapt to the evolving Covid-19 lockdown restrictions. In particular, this meant the Group was able to capitalise on the shift to increased levels of demand for delivery and takeaway, with a range of their locations (particularly in Greater London) also benefiting from increased working-from-home trends.


Tortilla believes they can continue to succeed despite the economic challenges facing the hospitality sector. One such reason for this is that Covid-19 has resulted in an increased number of vacant rental units on the market, with rent levels also rebalancing to more sustainable levels. This gives Tortilla the opportunity to accelerate its UK rollout strategy.


Scope for Growth


Tortilla has a fairly simple strategy and proposition to grow revenues over the medium term. Tortilla's key growth areas include:

  • The build out of new Tortilla units across the UK. Tortilla Group are targeting circa 45 new sites over the next five years.

  • New franchise agreements. International and UK opportunity (SSP or UAE franchisee).

  • Grow in store comparable sales through marketing, consumer proposition and investment.

  • Online delivery growth (Deliveroo contract)


Potential Challenges


Delivery Strategy
The table shows Tortilla's average weekly sales pre, during and post lockdown from January 2020 to August 2021. Key takeaways from this table are explained in the paragraph below.
Source: Tortilla's IPO Admissions Document

In the chart above, you can see Tortilla's average weekly sales pre, during and post lockdown, from January 2020 to August 2021. Comparing January 2020 to August 2021, delivery and takeaway revenues now account for c. 69% of revenues, (delivery c. 41% and takeaway c.28%) compared to c.39% of revenues in January 2020 (delivery c.17% and takeaway c.22%).


In 2015, Tortilla initiated a contract with Deliveroo, granting Deliveroo exclusivity rights over the order and delivery process for Tortilla. Although Tortilla have an "impressive commission percentage at Deliveroo" due to this exclusivity contract, which the Group believes will aid their delivery strategy long-term, Tortilla have been clear that they expect this agreement to result in a reduction in the Group's delivery sales in the short-term, as stated in their AIM Admission document. During the pandemic, Deliveroo granted a temporary waiver of this exclusivity agreement, allowing Tortilla to deliver via the Uber Eats and Just Eat platforms. This exclusivity agreement has now been reinstated, which may potentially hinder Tortilla's growth if the above trends towards delivery and takeaway continue.


Unfortunately for Tortilla, Just Eat outranks both Uber Eats and Deliveroo in 'interest over time' according to Google Trends (seen in the graph below). Losing the ability to advertise on the Just Eat platform could have a significant effect on Tortilla's deliver revenues. (Just Eat is represented by the red line, Uber Eats by the yellow, and Deliveroo the blue).


The chart shows Google Trends data comparing deliveroo, just eat and uber eats. Key takeaways from this chart are explained in the paragraph below the image.
Source: Google Trends

Competitors


The fast-casual dining market represents a £68 billion segment of the UK hospitality industry according to a 2019 report on the UK food industry by Euromonitor. Within this market, Tortilla operates within the Latin-American subsegment. The size of this subsegment was approximately £184 million in 2019 and is anticipated to grow by 7.4% between 2022 and 2023, which is 4.9% higher than the 2.5% growth expected through the wider market.


Tortilla operates in a highly competitive space, a space which they plan to assert themselves in through their cheap price point. Key competitors in the UK Latin-American fast-casual dining market include Barburrito (14 units), Chilango (14 units) and Chipotle (12 units), with other examples of Mexican-influenced dining concepts including Taco Bell, Wahaca and Benito's Hat.


The chart shows Tortilla's differentiated value versus its direct competitors Chilango, Chipotle and Barburrito. The chart shows that Tortilla has a cheaper offering both in-store and delivery compared to each of its competitors.
Source: Tortilla's IPO Admissions Document

As seen in the image above, Tortilla states that it beats all three of its direct competitors on price. Tortilla's focus on price-point in its IPO document is extremely important to consider here, as its Founder, Brandon Stephens, was clear that not much else differentiates Tortilla from its competitors in the Latin-American, fast-casual dining sector in his statement below.


"What we do and how we do it is very similar [to other burrito fast-casual restaurants]. Strikingly so in fact. [...] We serve a very similar set of products; the processes are the same and the environment is similar."


I find the in-discrepancy between competitors in the segment worrying, as there is no real moat protecting Tortilla's business, and Tortilla is operating in a segment with a large well known, premium operator from the US, Chipotle Mexican Grill, which can likely price its products at a premium to the less well known UK brand Tortilla.


The Group also competes against non-Latin-American fast-Casual brands such as Pret A Manger, Nando's, Itsu, Leon and Wasabi.


The image shows Tortilla's competitors' number of sites in the UK. Tortilla stands at 62, Barburrito and Chilango at 14, Chipotle at 12, Wasabi at 54, Leon at 66, Itsu at 70, Five Guys at 123, Nandos at 453 and Pret A Manger at 466.
Source: Tortilla's IPO Admissions Document

With similar store numbers to Itsu, Leon, Tortilla and Wasabi, Tortilla may have more to compete against than first thought. Although Tortilla clearly outpaces its direct competitors in terms of store presence in the UK, it still has some way to go to challenge the likes of fast-casual eating such as Pret A Manger.


Looking at the overall store count above, the major question to any potential investor should be whether Tortilla's offering is unique and compelling enough to deliver a store count similar to that of Five Guys, Nando's and potentially one day Pret A Manger. For this to happen, Tortilla needs to have some serious uptake and customer retention outside of London, particularly in areas in the North of the country.


Management Team


In all of Tortilla's press releases, across their website and in their IPO Admissions Document, the Group consistently highlight their Founder Brandon Stephens as being very much a part of the company's culture and its story. Stephens led Tortilla as its CEO up until 2014.


Tortilla's current CEO is Richard Morris, who joined the Group in 2014 and has a long history in the restaurant business, including being part of the original management team for Loch Fyne Restaurants, becoming MD in 2005 and selling the business to Greene King in 2007. He joined Tortilla in 2014 as MD and became CEO in 2021.


Tortilla's CFO is Andy Naylor, who joined Tortilla in 2017. Prior to working for Tortilla, he worked mainly with oil and gas companies, with his prior role at a large Russian gas giant. He then joined Gaucho restaurants as he wanted to work with something more 'tangible', selling the business to Equistone Partners.


The table shows the number of ordinary shares and the percentage of issues ordinary share capital before IPO and post-IPO for Richard Morris, Andy Naylor and Brandon Stephens. All three sold down their shares at IPO.
Source: Tortilla's IPO Admissions Document

Tortilla has a Founder-led message that permeates much of Tortilla's story. Looking at the register, Brandon Stephens had an amiable 12% of the business, which is good to see. However, since the IPO, Brandon has sold down his stake leaving him with just an 8.3% share in the business. In fact, all three of the key management team sold down their shares, with Richard Morris' percentage of issued ordinary share capital decreasing from 5.1% to 3.6% and Andy Naylor's stake dropping from 0.5% to 0.4%.


Founder Stephens appears to be involved in many other ventures, which could mean that his passion for Tortilla has waned. Stephens was Founder/CEO of REVL (the UK’s largest events marketplace), Chairman of Red’s True Barbecue (the largest BBQ chain in the UK), and Interim Director of e-commerce for Arcadia Group. Brandon currently advises TriSpan’s Rising Stars fund, a dedicated restaurant private equity program, whilst also acting as a NED for Thunderbird Fried Chicken Ltd and Mamma Roma Group.


Although Stephens' passion for Tortilla is highlighted in much of the company's rhetoric, it sounds as though he may no longer be an impassioned part of its story.


Financials


The table shows Tortilla's revenue, revenue growth, gross profit, gross margin, operating profit, operating margin, debt to equity ratio and ROCE in full year 2018, full year 2019, full year 2020 and half year 2021. Key takeaways from this table are explained in the paragraph below.
Source: The Twenties Trader

The financials for Tortilla are a mixed bag. The Covid-19 crisis has occurred fairly early on in Tortilla's financial history, therefore, we can't take average revenue growth into too much account (unless you believe the pandemic is here to stay indefinitely). Despite the lockdowns in 2020, Tortilla only lost 24% from its peak revenue base in 2019, which is quite a solid performance compared to food service peers. H1 2021 results show an impressive bounce back in performance, with Tortilla on track to surpass revenues in 2019 by the year end.


Gross margins are of particular interest to me as a potential investor, ratcheting up to 80% in H1 2021. These impressive margins are a sign of how profitable Tortilla's business can be when operating at full scale in a few years down the line. However, Tortilla is yet to turn impressive gross margins into operating profit, with poor conversion in the years 2018, 19 and 20, albeit improving with a 15% operating margin in H1 2021 (which is too early to tell whether Tortilla is operating with any level of long term efficiency).


Unfortunately, the Tortilla balance sheet also looks heavily laden, with recurring losses being held on the balance sheet as negative retained earnings, resulting in the debt to equity ratio distortion. I would expect in the aftermath of the IPO that Tortilla's balance sheet will start looking cleaner, but we will only be able to tell Tortilla's financial position in the next update to the market.


In summary, some aspects of Tortilla's financial metrics show promise of what could come (good gross margins, retention and growth of revenues). However, it is much too early to get a full understanding of how good quality a business Tortilla is, thus adding an element of risk to an investment.


Summary and Valuation


Well-run quick service franchise businesses can be fantastic return vehicles for investors, see past returns from Dominos Pizza Inc, Wingstop, McDonalds and even some of the British chains such as Greggs plc. Typically, the recipe for success in quick service is firstly a winning customer proposition that is differentiated (through taste, experience, customer service or digital proposition); secondly land to expand, which is best done in the US where the market is large enough to expand into (or by having a concept that works in many locations in a smaller market); and thirdly, the business must have fantastic financial metrics, both for the parent business and its franchisees.


With the above in mind, I am not sure Tortilla has all the ingredients to turn itself into a winning franchise yet, which could be held back by an undifferentiated customer proposition, a weak brand versus in class peers (Chipotle MG) leading to unattractive pricing and a lack of land in the UK that is viable for expansion.


However, we have to consider we are still early on in the Tortilla story. Investment in the business will occur post-IPO and brand momentum may start to build in the coming years allowing for differentiation and price elevation.


The company trades on roughly 12x forecast operating profit in 2021, which isn't overly expensive, but without a track record and very few broker earnings, estimates valuation remains unclear. For now in my opinion, Tortilla is un-investable.


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At the time of writing, The Twenties Trader did not own shares in Tortilla.


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