The shares of Chipotle Mexican Grill (NYSE:CMG) have rallied close to 30% in 2013 and are currently in the range of $360-370. Chipotle’s stock went as high as $440 in the first half of 2012, but after a couple of disappointing earnings in a row, it tanked to $240. However, the stock has consolidated since then helped by solid earnings in the last two quarters. The company released its first quarter results last month, which were slightly better than the market expectations.
The restaurant chain is famous for its burritos and continues to expand within the U.S. with plans to open 180 new stores this year. Besides the new additions, here are some other trends to watch out for in subsequent quarters and in the long run.
1. Comparable Store Sales Slowing
Chipotle’s comparable store sales growth stood at a lowly 1% in the first quarter. However, there were two additional working days in the previous year quarter. So an apple-to-apple comparison would result in a 3% rise in comparable sales. Posting solid same store sales in the first quarter was always going to be a challenge since the corresponding figure stood at a whopping 12.7% in the previous year quarter. The company should get some respite from the third quarter when it faces a better comparison.
Comparable sales, or same-store sales, is an important measure to gauge a restaurant’s performance since it only includes the restaurants open for more than a year and excludes the effect of currency fluctuation.
Chipotle also plans to raise its menu prices (~3%) on a nationwide basis by the end of summer. The pricing gains should boost the comps sales as well. Moreover, the restaurant’s recently addition of Sofritas and the introduction of Margarita cocktails could further pep up sales.  We are quite confident that the company can achieve a better set of numbers in the coming quarters.
2. Margin Risk A Consideration
According to Chipotle’s management, the company needs about 3% comparable sales growth to maintain its margins. What that basically means is that beyond 3%, the company can leverage sales growth to more than offset the rise in fixed costs such as labor and occupancy. As discussed above, we expect better comps for the rest of the year and some improvement in margins.
On the other hand, the prices of beef and other meat products continue to surge. So, in spite of a menu price increase, we could see some upward pressure on the cost of raw materials. Thus, any gains made due to a price increase or the introduction of new products could be negatively impacted by soaring food prices. Overall, we feel that margins are likely to remain in a narrow range.
3. Store Size Is Declining
In the long run, we are are slightly cautious on the stock due to the company’s declining store size. The average size of a Chipotle restaurant has declined from 2,600 sq. ft. in 2009 to 2,535 sq. ft. in 2012. This means that the average sales growth per restaurant has not kept pace with that of comparable sales. For example, in 2011 and 2012, the average restaurant sales for Chipotle rose 9.4% and 5.0% respectively while the comparable sales figure stood at 11.2% and 7.1%. Smaller stores could result in slower top-line growth and possibly lower cash generation than what one might anticipate when looking at store additional alone. 
As the company has penetrated many of its target markets, the management could be more cautious about cannibalization thus leading to smaller store sizes. This also happens in cities where competition is higher. This maybe one of the reasons why Chipotle’s average store size has decreased over the years.
Going forward, we expect the average restaurant size will continue to face downward pressure as the penetration of the restaurant chain increases in the U.S.
We have a price estimate of $348 for Chipotle Mexican Grill, but we are in the process of revising our estimates to incorporate the latest earnings.Notes: