Should Falling Comparable Restaurant Sales Worry Chipotle Investors This Quarter?

| About: Chipotle Mexican (CMG)

Summary

Chipotle Mexican Grill is a fast-casual restaurant chain, a sector that is currently booming.

Since it’s founding in 1993, it has grown to 1,595 stores globally with plans to continue increasing that number.

In order to estimate the potential four-year returns of CMG, it is important to understand how CMG will deliver returns to investors.

In the past, Chipotle Mexican Grill (NYSE:CMG) has generously rewarded investors with strong revenue growth and increasing pre-tax margins. This has led to a dramatic appreciation in the share price of CMG since it went public for $52 per share in 2006. As of July 16, 2014, CMG has returned 33.27% compounded annually for investors and due to the high price to earnings multiple investors are willing to pay, it suggests that they expect those returns to continue. The trend of CMG shares suggests that the stellar performance will continue but likely not forever as investors of CMG learned when shares plummeted from the low $400s to the mid-$200s during 2012.

Breaking down the gains in revenues CMG has recorded for the past several years, it is apparent that gains are driven primarily by new store openings. For FY 2011 CMG opened 146 new stores, for FY 2012 180 and for FY 2013 185 new, net of relocations. For FY 2014, CMG expects to see 180-195 new store openings bring the total number of locations to 1795 by year-end. The new store openings over the next 4 years are key to growth because adding new restaurants accounts for the bulk of sales growth at CMG. For 2015, CMG has not provided specific guidance but based on past trends, between 180 and 200 store openings seems reachable factoring in the growth of yearly openings seen since 2011. If this growth in yearly openings were to persist, CMG could hit 2,500 stores by Q4 2018. After 2015, it is prudent to assume that new store openings will drop off slightly as CMG approaches saturation in the domestic market.

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Source: Google Finance.

In addition to new store openings, CMG sales from comparable restaurant sales of 11.2% for FY 2011, 7.1% for FY 2012 and 5.6% FY 2013 added further revenue growth. Comparable restaurant sales numbers are based on locations open at least 12 months. Although the number for stores opened per year is accelerating, sales growth from existing stores is beginning to decline. This suggests this may no longer be a significant contributor to revenue growth.

Falling same-store growth also may a sign that CMG is reaching saturation in some of its markets and therefore comparable store sales growth may be a leading indicator for CMG overall revenue growth. As previously mentioned, new store openings are a key driven of revenue growth at CMG, so falling comparable stores growth suggests that new store openings may fall as well. If management at CMG planned prudently, it would open stores in the most lucrative locations before moving to openings in less desirable locations.

This would suggest stores opened later in the growth cycle may have lower sales prospects thus accelerating the slowing of comparably store growth once those locations are open 12 months and included in the statistic. Although these assumptions are qualitative, it is notably that new CMG openings are close to old locations or are in less densely populated areas. A look at the quarterly breakdown of store openings and comparable store growth from sheds more light on the potential for store openings growth to slow with comparable store growth.

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Source: Google Finance.

With CMG's earnings report on July 21st nearing, investors should be watching comparable store sales growth for signs of a further slowdown or re-acceleration in growth. The last time CMG reported poor comparable sales growth in Q2 2012, shares dropped 22% following the reports release. That led to a steep decline, with shares losing almost half their value.

Conclusion

With CMG shares rallying recently over $600 and near all-time highs, investors must determine how they want to position themselves ahead of the upcoming earnings report. I would recommend taking gains or purchasing puts for this upcoming earnings call. That's because due to the recent trend of slowing same-store sales growth, it presents a situation where CMG must reverse this trend and meet their stated target of same-store sales growth in the upper single digits. After CMG announced price increases this spring, shares rallied, suggesting that the market is pricing in higher expectations for same-store and overall sales growth. This may be the case, but considering the recent price action and same-store sales growth trends, this all suggests to me that the chances of a post earnings report decline are greater than 50% this quarter.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a short position in CMG over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.