Chipotle Mexican Grill Inc (NYSE:CMG) is scheduled to announce its Q3 earnings on October 18, 2012. The stock was punished after the company announced its Q2 earnings as the comparable sales growth failed to live up to expectations. The stock had recovered close to 20% in the following months, but with hedge fund mogul David Einhorn recently advising investors to short the company on slowing comp sales, the stock surrendered these gains.
Comparable sales are an important indicator of a restaurant chain’s performance since they exclude the performance of the newly opened restaurants, the sales of which can be unusually high or low. Note that all of Chipotle’s restaurants are company-operated and are not franchised so the restaurant’s sales are reflected in the company’s income statement.
Comp Sales to Remain Close to Q2 Levels
Part of the reason why the comparable sales slowed down in the second quarter was a lack of menu price increases. And since the company does not plan to raise prices in 2012, we expect the comparable sales to remain relatively subdued this year compared to the previous year.
Chipotle’s comparable sales grew 11.2% in 2011 (y-o-y) out of which 2.9% was contributed by menu price hikes. In the first quarter, comparable sales growth was 12.7% helped by menu price hikes (implemented in Q2 2011) and a rise in customer traffic. However, the figure decelerated to 8% in the second quarter, which did not go down well with the investors.
Management expects comp sales growth to be in the mid-single digits, and the company has done well in that regard – exceeding its own expectations. The market probably became too optimistic after its first quarter performance. The top-line growth will be aided by comp sales growth as well as sales from the newly opened restaurants. Overall, the company aims to add 155-165 restaurants in 2012, of which 87 were added by the end of the second quarter.
Margins May Show Some Weakness
The reason why margins improved in the preceding years is because 9-10% comparable sales allowed revenue growth to outpace the growth in expenses. A look at the following table shows this historical trend.
|Food and Packaging Costs (as a % of Revenue)||32.4%||30.7%||30.6%||32.5%|
|Labor and Occupancy Costs (as a % of Revenue)||33.7%||32.9%||31.7%||30.4%|
It is clear that labor and occupancy costs have continued to decline due to strong top-line growth. Note that these are fixed costs and remain more or less constant, irrespective of company sales. Thus, higher comparable sales growth will lead to strong top-line growth and will reduce labor and occupancy costs (as a % of revenue). With the comp sales for this quarter expected to be lower than the historical figures, labor and occupancy costs might not benefit to the same extent.
Historically, food, beverage and packaging costs have stayed in a narrow range of 30.5% to 32.5%. In the absence of any menu price hikes and bad weather pushing up the commodity prices further, food, beverage and packaging costs (as a % of revenue) should increase.
Overall, margins could witness some deterioration as positive gains in labor and occupancy costs could be more than negatively offset by higher food costs. On the bright side, margin erosion if any should be insignificant since the comparable sales growth is expected to remain solid. 
We have a $402 price estimate for Chipotle, which is more than 30% above the current market price.Notes: