At times, missing earnings estimates can be devastating for a stock price; other times, investors hardly notice the widely reported-on figure. The latter was certainly the case for Chipotle Mexican Grill (CMG), which recently reported a relatively steep bottom-line disappointment and watched its stock rally to the tune of 16%. CMG shares continue to trade near all-time highs.
Top-Line Advances Boost Optimism
Chipotle reported earnings of $2.66 a share, which was well short of Value Line’s estimate of $2.75 and the Wall Street consensus of $2.78. Even though $2.66 represented a year-over-year advance of 17%, a miss of this magnitude is usually enough to send investors packing. However, revenue advances not only kept investors interested but caused many to double down. The top line rose 18%, to $826.9 million, about 1% better than expectations. Same-store sales gains were also very good, at 6%, which easily beat forecasts of a 4% advance. Perhaps the biggest source of optimism was management’s major revision to guidance. It is now calling for comparable-restaurant sales growth to be in the mid-single digits this year (up from low-single digits). Chipotle will need to report same-location revenue growth of 5% in the fourth quarter to reach this goal, which, again, is very good. All of the optimism surrounding sales added up to an earnings miss that simply didn’t matter.
Why Investors Are Excited
It is no secret that the current state of the domestic economy is not what most were hoping for. In light of the ongoing economic uneveness, uncertainty regarding future prospects, and the pains associated with the prolonged U.S. government shutdown, consumers have really pulled back. Given the lackluster consumer environment, it was very surprising that same-store sales advanced at such a robust pace (nearly two percentage points better than expectations) and even more shocking that management raised its revenue guidance. Moreover, it wasn’t price hikes or gimmicks that drove the top line higher. Instead, it was effective advertising and marketing (especially through social media) that led to increased foot traffic and higher volumes at the chain’s 1,500-plus locations. The catering business is also growing at a brisk pace, which is another good sign, and there is always the potential for product price hikes and increasing the advertising budget.
The earnings picture is a bit cloudy, but most analysts are still looking for 20%-plus share-earnings growth this year. Food expenses are up considerably, owing to increased produce (tomatoes, corn, and tomatillos) prices, higher dairy and chicken prices, and elevated oil (sunflower and rice bran) prices. This input cost pressure is unlikely to abate any time soon, and will probably weigh down margins at least through the early stages of 2014. Outlays associated with opening new stores, however, will eventually start to decrease. The company is on pace to unveil 180 new restaurants this year and expects to open a similar number in 2014, but we think this pace will eventually cool down. Any slowdown here would surely provide a nice boost to EBITDA margins. All told, the earnings shortfall could be one-time in nature; bottom-line pressure could linger on in the year ahead; or analysts’ expectations could be too high given the chain’s intense focus on store expansion. Our sense is it won’t matter much, so long as Chipotle keeps reporting stout sales advances, and all signs point to handsome top-line growth. After all, Chipotle is serving up what consumers are looking for: value, convenience, and quality.
Chipotle has carved out a nice (and very profitable) niche in the fast-casual dining space, but it is tough for us to recommend CMG stock at the current levels—the P/E is currently over 47x, which is very high even for a high-growth issue like CMG. Compare that to the P/E of McDonald’s (MCD – Free McDonald’s Stock Report) stock or that of Yum! Brands (YUM), and it is easy to see why we are a little hesitant. However, for investors willing to pay for growth prospects, we think the chain has lots of room to expand both domestically and internationally. There are just over 1,500 Chipotle Mexican Grills out there, compared to nearly 35,000 McDonald’s and about 6,000 Taco Bells. Moreover, almost all of Chipotle’s restaurants are located in the United States, with just a handful located in the U.K., France, Canada, and Germany. So, while the P/E ratio could tail off some in the not-too-distant future, there is definitely potential for Chipotle to expand its footprint and grow its bottom line exponentially over the next decade or so.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.