After providing investors with weak preliminary results at the ICR Conference in January, Chipotle (CMG) announced final fourth quarter results, which were relatively in line with what we saw a month ago. Revenue grew 17% year-over-year to $699 million, in line with consensus expectations and prior guidance. Earnings per share were a penny below expectations, growing 8% year-over-year to $1.95 per share. Same-store sales for the quarter grew 3.8%, also equal to what the company provided us a month ago.
Rising input costs continue to hurt profitability, as the cost of food and beverages was 130 basis points higher at 33.5% of revenue. We think the firm could easily cut costs, but its commitment to high-quality ingredients and locally-sourced inputs aid in stronger brand perception (and are one of the firm's keys to success, in our view). Restaurant margins remained strong, declining 150 basis points year-over-year to 24.6%; we can clearly see most of the decline was directly related to lower food margins. CFO Jack Hartung seems confident that the company can raise prices to offset food inflation, noting on the conference call:
"As we hit the debt ceiling crisis and you know how people are feeling with their payroll tax increasing we'd rather be more patient, we rather see what happens with the economy what happens with our transaction trend, and if we are little late to the game in raising prices, that's okay because as soon as you raise prices the margin of our model bounce right back to where they can and should be on a going forward basis."
Same-store sales for the quarter increased 3.8% year-over-year, and this is where we see the problem for Chipotle. Competition from Taco Bell (YUM) has intensified, as that restaurant posted 8% same-store sales growth. Taco Bell's Cantina Bell menu offers a similar product at a substantially lower price. If a price increase is enacted, we believe more customers could shift towards eating at Taco Bell.
There remains a compelling argument that Chipotle attracts a more health-conscious consumer, and since Taco Bell isn't seen in a healthy light, we don't see it stealing much traffic. Although locally-sourced meats and vegetables may be "healthier" than industrial farm product, Chipotle burritos are a high-calorie meal, and we doubt those most sensitive to health concerns are even eating regular meals at Chipotle.
With a $3-$4 spread between Chipotle and Cantina Bell burritos (assuming price increases), locally-sourced organic meats may no longer be as relevant in the decision making process. We also see increased prices as potentially having a negative impact on high-margin beverage sales, as well as sales of sides. Management is already saying beverage sales have been weak, so additional price increases on the firm's core product could discourage beverage purchases even more. This may be why the company is forecasting 2013 same-store sales growth of flat to low single digits.
Catering seems to be an opportunity that the company is fairly excited about, but we're not sure how exactly that will play out. Part of Chipotle's success is based on its customizable food choices, and quality food. With catering, customization becomes less possible, and often times, catered food may not be served properly, obscuring the underlying product. We're skeptical that this new business will be able to boost sales materially.
Still, the firm has plenty of room to expand its restaurant footprint both in the US and abroad. Chipotle should open 165 to 180 new restaurants in 2013, and its international recognition remains exceptionally low. We're not sure if the Chipotle model necessarily works everywhere, especially since a heavy Mexican tradition is already embedded in American culture.
Yet, McDonald's (MCD) proved that fast food chains can adapt to local markets, particularly if it provides its customers with what they want. Nevertheless, we think shares look fairly valued at current levels, and we could be interested in opening a put position in the portfolio of our Best Ideas Newsletter if shares continue to rally from here.