Chipotle: Strong Quarter, but Stock Is Down

Wednesday night after the close, Chipotle Mexican Crill, Inc. (CMG) reported earnings that were surprisingly strong. Revenue came in at $305.3 million, up 28.3% from the same quarter last year. Analysts were anxious to get information on comparable store sales which were up 10.2% for stores open more than one year. The increase was driven primarily by higher traffic with only a small portion due to higher pricing.

On the earnings side, the company beat expectations posting EPS of 0.52. As far as guidance is concerned, management noted that comparable store sales would likely be up in the mid single digit percentage points for the full year, which is better than the low single digit guidance that was given on the last call. Despite what appeared to be a strong report, the stock dropped nearly 10% on the second highest volume of the year.

During the conference call, management made several comments about the extremely difficult economic backdrop that the company is working with. While it is certainly a positive that the company was able to perform so well amidst the slowing economic activity, it is likely naive to assume that the company will be able to continue to operate without being affected.

A slowing in consumer spending has affected sales at many quick service restaurants as well as casual dining, and this dynamic is seen across a broad assortment of food concepts. While Chipotle may be the “best of breed” in this market, it is still operating in a troubled sector of the economy.

One of the most daunting challenges the company faces is in rising food costs. Inflation in commodity prices remains high on the list of concerns for management and while the company has locked in cheese and tortilla costs for the foreseeable future, management pointed to increases in avocados and steak as additional items to be watched. Overall the company expects to see a continued rise in food costs for 2008 and into 2009.

While some stores have increased prices coinciding with the introduction of naturally raised beef, management does not plan on a company-wide price increase at this point. Without higher prices, margins are likely to be squeezed. In fact, management explicitly stated that “it's going to be tougher for us to hold onto our gross profit.”

Many in the bull camp point to the huge opportunity for additional stores to be opened across the state. While Chipotle has certainly shown skill as to how and when to select new locations and new markets for its restaurants, there are some concerning statistics in regard to new store openings.

The average store in the chain operates at a $1.77 million average revenue base. Typically, new stores have opened at roughly 80% of this level the first year. After about 3 years these new stores are expected to have matured to the place where they are operating at a mature sales volume.

However, as the company shifts more of its openings to new markets, it has begun to see the average new opening fall into the 70s as a percentage of the average store sales. This is especially concerning when management notes that some new stores are struggling just to clear $1 million in sales. Now the overall trend is still for new stores to be accretive to earnings, but calls into question how robust growth targets may be.

In my history of trading, I have found that when stocks decline on what is perceived to be good news, the likelihood of further weakness is high. The multiple has come in to some degree but still is at a level that reflects a degree of optimism that investors carry. While the management team is strong, and the store concept is very appealing, I believe the stock has further to go in its decline.

Technically, the stock broke through the 50 day average which while not a magic number, will attract the attention of many traders. Finally, the overall economy is unlikely to provide very many positive data points to push the stock higher over the next few months. I am and expect to continue to remain short this name.

CMG Notes

Disclosure: Author has a short position in CMG.

Comments

[BorisB]

valuation metrics are a hot topic. what do you have to say about the 12 month trailing and 2008 (estimated) annualized price to sales ratio of the discounted B shares?