Last month, Chipotle Mexican Grill (NYSE:CMG) announced strong third quarter earnings. The highlight of the result was the same-store sales growth of 6.2%, which beat the market expectations. Shares of the company have gained more than 20% since the results were announced. 
For a restaurant chain such as Chipotle, the comparable sales metric is the most important number to watch out for. Comparable sales, or same-store sales, help investors gauge a restaurant’s performance since it only includes the restaurants open for more than a year and excludes the effect of currency fluctuation. The company gives the guidance for the number of restaurants to be added in the coming fiscal year, to which it has generally conformed to, in the past. Therefore, the sales forecast boils down to the sales growth to a large extent.
We have a $416 price estimate for Chipotle, which is about 20% lower than the current market price.
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Back in the first quarter of 2012, Chipotle reported same-store sales growth of 12.7%.  The company’s share went as high as $440. A couple of weak results later, Chipotle’s shares had fallen to $237. Now with the company beating market expectations in October 2013, shares have spiked more than 20%. However, if the company were to face a few hiccups in the upcoming quarters, shares could very well crash again.
While Chipotle’s latest earnings were surely strong, cautious optimism needs to be exercised following the earnings release.
The results in a particular quarter are also dependent on the previous year figures. Since Chipotle’s same-store sales in the third quarter of 2012 were weak, the restaurant had a relatively easier comparison in the third quarter of 2013. While the same-store sales growth was 6.2% in the latest quarter, the two year average stands at 5.5%. While the current quarter growth figures may be good, they may be nothing to craze about especially since there was a greater scope to improve the sales per restaurant back in 2011. Similarly, the same-store sales stood at a meager 1.0% in the first quarter of 2013 since the company faced a difficult environment over the previous year figure (12.7% same-store sales in Q1 2012). The two year average comes out to be 6.6%. Thus, the fact that same-store sales accelerated from 1.0% in Q1 to 6.2% in Q3 might not be an accurate representation of the improvement in Chipotle’s performance. A 20% jump in the stock price could really be an overreaction.
It is also important to note that there were a number of factors such as several menu additions and incremental revenue from catering, which boosted the overall sales in the third quarter. Chipotle added an usually named vegetarian item called ‘sofritas’ at the start of the year which seems to be a hit among the customers. About a quarter of the total restaurants within the U.S. were serving it by the end of the third quarter and the item already accounts for 4% of the sales at the restaurants at which it is being served. In addition, Chipotle also introduced margaritas at the start of the year. While Chipotle should be credited for efficiently executing these strategic changes, the fact is that generating sales growth of this magnitude might not be sustainable simply because one cannot expect so many one-time revenue additions in each and every quarter.
Despite the strong sales, Chipotle’s margins still remain under pressure. The cost of food, beverage and packaging (as a % of overall sales) jumped 100 basis points to 33.6%.  Overall, the restaurant margins were down 60 basis in the latest quarter. Chipotle has been reluctant to pass off the higher costs of food materials to customers. At the start of the year, it intended to raise the menu prices beginning from the summer but has since decided to push these price hikes to the start of next year. Menu price increases should bring some margin relief but could also drive away some of the price sensitive customers. Thus, balancing sales vs margins remains another challenge for the company in the near term.Notes: