I was asked a question about Chipotle Mexican Grill (CMG) by Jabob in Member Chat last night that triggered a very detailed answer so I thought I'd share it here.
Unfortunately, Seeking Alpha does not pick up my color coded highlights of the conference call (green is good, red is bad) but you should get the gist of it. (You can read the transcript of the whole conference call here.)
Jabobeast - Phil, do you think CMG actually opens at these high levels (278) or is this AH action a bit too much?
CMG/Jabob - I really hate to give an opinion at this point. They made $1.47 a share, so let's call it $6 a year. Even if we call it $7 (assuming growth), that's 39 times forward earnings. Nobody gets that kind of valuation - it's irrational! As with everything else, there is the assumption that margin pressures are temporary and every company on earth will be able to pass along higher input costs without giving their own workers wage increases (which would further cramp margins) and that the Government will continue not to tax them (because we don't need to balance our budget - ever) and that sales will keep expanding as all the unemployed people rush out to BUYBUYBUY whatever they are selling.
Don't forget CMG just had to lay off 1,200 illegal workers and the Government is breathing down their necks. Did they replace all those people right away with workers who were just as cheap so it won't affect Q1 earnings? In the CC, they are on track to open as many stores in 2011 as 2010 but that is SLOWING growth as they are bigger now than they were in 2010 so they should be opening 10% more stores. That's not a nit-picky thing because now would be the time to expand if they had faith in long-term growth as rents are cheap and prime space is available and labor is plentiful and cheap. If not now, when?
On illegal employees: "As you can imagine, this has been disruptive. We had to hire hundreds of new employees, and we're in the process of training these new employees to provide a great Chipotle experience to our customers in Minnesota. We also received a similar notice of inspection for our restaurants in Virginia and Washington D.C., and we are in full cooperation with ICE officials there. This has not been an easy process for anyone involved, but we're navigating our way through it, and we're learning as much as we can so that we can avoid this sort of disruption in the future."
Sales were up 20.9% from last year with 9.4% driven by same store-growth. Keep in mind they opened about 130 stores in 2009 and again in 2010, which accounted for 25% of their chain, and of course the 2009 stores had huge growth in their 2nd year but this year, they are basing off 1,100 stores which will grow (giving huge benefit of doubt) 9.4% but that will only be augmented by 140 new stores (13%) at 100% growth so not the same bang for the buck as they got last year. With a p/e this high, as soon as there are signs of deceleration, I think people will begin to bail.
Our comps held up well throughout the fourth quarter, but it's been pretty volatile so far in 2011 with extreme weather throughout much of the country. While we believe the underlying transaction trends are healthy, we do prepare against progressively tougher comps each quarter. And therefore, we reiterate our guidance of low single-digit comps for the full year of 2011.
Food costs were 31% during the quarter, which was up 90 basis points from last year and up 40 basis points versus the third quarter. Prices for avocados, beef and cheese were higher in the quarter, which were partially offset by decreases in rice and corn. Commodity inflation has continued to push our food costs higher in 2011 already, and we expect continued inflationary pressure on many of our ingredients, especially chicken, beef and avocados during the year.
Though we have contracted for most of our corn for our salsa for the year, reports of a continuing or even worsening supply shortages of corn will only add to inflationary pressure on the meats that we serve. Using the fourth quarter food cost of 31% as a starting point, we anticipate additional overall food cost inflation will likely climb to the mid-single digits during the year.
In addition to the growing underlying food inflation, we're in the process of sorting through the impact of recent freezes in Mexico and Florida, where our tomatoes, green peppers and tomatillos are currently grown. The cost of these items has surged threefold as a result of severe crop loss, which, if we remain fully supplied, would increase our food cost by over 200 basis points.
Over the next few months, until the Florida harvest season resumes normal production, we will evaluate the quality and quantity of tomatoes, green peppers and tomatillos available and make sure we only serve high-quality produce that our customers have come to expect from Chipotle. And during this time, we may experience shortages or surging food costs or both.
So it's obvious that food inflation is real, and it appears will get worse before it gets better. But what's not obvious is the exact timing and magnitude of inflation on the items we serve, how much is sustainable versus driven by temporary conditions such as weather and, perhaps most importantly, what's the appetite our customers have to absorb these higher costs. While we continue to believe we have as much, if not more, pricing power than other restaurants, we plan to hold off on any menu pricing decisions until later in the year, which will allow us to see how inflation plays out on a sustained basis and allow us to see how consumers react to price increases from other restaurants and grocers.
The company bought $126M of their own stock (2%) last year at an average of $176 a share. That accounts for 2% of their income growth right there (.12 per share). I love that trick, don't you? The closing statement had a lot of hedging in it:
While in the short-term we face challenges to our model, including growing commodity inflation,inefficiencies related to retraining hundreds of new employees in Minnesota as well as severe winter weather across most of the country, longer-term we believe our margins and our returns are largely sustainable. Inflation, in particular, could be at least partly, if not fully, offset by immediately raising prices. While we have worked hard to regain the strong transaction complementum [ph] [44:41], and with tougher comparisons ahead of us as we progress throughout the year, we're not in a hurry to risk interrupting those trends by raising prices on what might see a fragile consumer.
In addition, while difficult to predict with certainty, we expect commodity inflation will steadily increase our food cost during each of the next two or three quarters. So rather than strike preemptively by raising prices now, we plan to hold tight on our menu pricing till the second half of the year both to allow our transaction to hold as strong as possible and to allow us to fully see the timing and magnitude of sustained inflation, even though this means our margins will be pressured over the next few quarters. Longer-term, assuming we possess the pricing power with our customers we think we do, we continue to believe our margins and returns are sustainable.
Really? Is this the kind of company we pay 40 times FORWARD earnings for (keeping in mind forward is assuming 17% growth above the current Quarter) just to get DOWN to 40 times earnings.
What a load of BS!
Disclosure: I am short CMG.