Chipotle Mexican Grill (NYSE:CMG) delivered excellent second quarter figures on July 21, continuing the momentum witnessed in the first quarter. The company’s revenue for the quarter rose to $1.05 billion, up 28.6% year-over-year, primarily driven by an increase of 17.3% in the comparable restaurant sales. Same store sales, or comparable restaurant sales saw tremendous improvement due to the increased traffic and increased average spend per visit.  Comparable restaurant 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.
In line with its guidance of opening up 180-195 new restaurants in 2014, Chipotle opened 45 new outlets this quarter, taking its total outlet count to 1,681. The company expects opening sales volume of these new stores in the $1.7 million to $1.8 million, up from previous range of $1.6 million to 1.7 million. Diluted EPS for this quarter rose to $3.50, up 24% from same period last year.
We have a $574 price estimate for Chipotle, which is about 2% lower than the current market price.
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Price Hike Drives Revenue Growth
The restaurant industry has been struggling with the rising food costs for the last couple of quarters. With no sign of relief, major fast-food brands such as McDonald’s (NYSE: MCD), Subway and Burger King (NYSE: BKW) and fast-casual brands such as Chipotle were forced to pass on the rising input costs to the customers. The prices of beef, avocados and cheese have increased significantly over the last few months.
For Chipotle, food costs were nearly 34.6% of the total revenues, an increase of 150 basis points. The increased food cost was primarily a result of increased prices of beef, avocados and dairy products. In comparison to this, overall inflation is reported to be around 2% for a wide range of food products. Two years of drought conditions in some parts of the U.S. were the main reasons for this significant increase in prices. 
To counter the inflation, Chipotle raised the prices of its steak burritos by 4%-6%, or 32-48 cents, whereas the overall menu prices went up by 6.5% on average and all this without hurting the customer traffic.  According to the Bureau of Labor Statistics, U.S. consumers paid 2.6% more at eateries (food away from home) in 2013 over the last year, while food prices were 6.2% higher at supermarkets or retail stores.  Therefore, consumers got a wide idea of price inflation for the core items and they reacted less against price hikes at restaurants. As a result, average spend per customer visit rose 5% and as the guest count was unharmed, this led to a significant increase of 15.5% in comparable restaurant sales.  Chipotle has been seeing increasing sales even during times when its competitors are struggling with flat or marginally rising sales. Effectively, strong same store sales led to excellent revenue figures.
To meet high standards and maintain customer confidence, the company started sourcing grass fed beef from Australia, where beef cattle is raised entirely on grass feed without the use of antibiotics. However, Chipotle still maintains loyalty to the domestic ranchers and considers this move as a necessary step in its food with integrity program.
Higher Marketing Costs Hurt Operating Margins
The company’s restaurant level operating margins dropped 30 basis points to reach 27.3% as compared to margins in Q2 of 2013 fiscal. The decrease in the margins was due to higher food and marketing costs, partially offset by lower labor and occupancy costs. Marketing costs rose to 2% of sales in Q2, compared to about 1.5% last year, where promotions and fund raiser costs contributed nearly 20 basis points. Chipotle expects the marketing cost to be high in the third quarter too, as the company continues its ‘better ingredients’ advertising campaign in over 30 markets and over 1,000 restaurants.
Catering Services: An Added Boon
Chipotle’s excellent performance in the second quarter also partially benefited from the catering sales, which were 1.6% of revenue, an increase of 130 basis points year-over-year. Chipotle’s total online catering and fax orders reached 6% of sales in the quarter. Catering sales benefited 50 basis points in the second quarter due to special events like graduation parties which is seasonal and hence, the company expects the sales to taper slightly in the next few quarters.
Sofritas-the Vegan Dish: An Outperformer
Chipotle has always focused on introducing new organic and hygienic food items. In the second quarter, the company introduced a new vegan menu items- Sofritas, which proved to be a success among the vegetarians, as well as non-vegetarians. ((Review: Chipotle’s Tofu Sofritas)) In all the 1000 outlets, where the Sofritas are available, it accounts for nearly 3.5% of the entrees in the restaurants. Chipotle expects to introduce Sofritas in all the restaurants by the end of this year.
The company has always been successful in providing its customers with an extraordinary dining experience and periodic expansion of its menu with new and innovative dishes.
Decent Pace In Expansion & Focus On Diversification
Chipotle added 45 new restaurants in the second quarter, bringing the total restaurant count to 1,681. The company’s pace is in line with its guidance to open 180-195 restaurants by the end of 2014 fiscal. Although most of the company’s restaurants are located in the U.S., there’s still a lot of scope for domestic expansion. Chipotle expects around 70% of the restaurants to be in established markets, 15% in the developing areas and the rest 15% in the new untested U.S. markets.
Chipotle ended the Q2 with $1.1 billion in cash and cash equivalents and believes to use most of the cash to invest in well performing and high returning restaurants. On the other hand, it continues to introduce diversification through ShopHouse and Pizzeria Locale and is optimistic with the growth potential of these brands.