Chipotle’s (NYSE:CMG) reported strong Q2 results with a 22% quarter over quarter increase in revenues to almost $572 million. Chipotle competes with restaurant chains like McDonald’s (NYSE:MCD), Burger King, Yum Brands! (NYSE:YUM) and Papa John’s (NASDAQ:PZZA). All of these stocks are competing with significant food inflation concerns. However by improving operating efficiencies and through careful price increases, we believe Chipotle can navigate these headwinds. Nonetheless, our current price estimate is $276 price estimate for Chipotle’s implying a 20% discount to the market price.
What is driving Chipotle?
Chipotle is known for high-quality raw ingredients, classic cooking methods and a distinctive interior design. We believe Chipotle’s brand awareness and customer loyalty are the key drivers that have led to a strong performance by Chipotle amidst severe cost concerns in the food and beverage industry. Chipotle’s comparable restaurant sales, a retail metric to measure a company’s profitability, witnessed an increase of 10% compared to Q1 2010. Its comparable restaurant sales growth was primarily driven by increased traffic in the quarter. During the quarter, it opened 39 new restaurants bringing the total restaurant count to 1,131.
Increasing Margin Concerns Trouble Chipotle
Like other fast food chains, Chipotle is juggling with increasing food costs. Its restaurant level operating margin was 25.8% in the quarter, representing a decrease of 110 basis points over the prior year period. The decrease was primarily driven by food cost inflation partially, which was offset by leverage from comparable restaurant sales growth.
In the past three years, Chipotle bore the brunt of the increased costs itself and did not pass on these costs to its customers by way of higher prices. However, this time, the company has increased prices of its offerings to offset these cost pressures. Chipotle has started with price increases in northeast and southeast U.S. and will roll out to other regions as well.
We believe over the short term, Chipotle would be bogged down by these cost pressures. However, we are also optimistic and confident about Chipotle’s brand image, customer loyalty and use of fresh and high-quality raw ingredients. Therefore, over the long term, we believe Chipotle would be able to withstand these pressures and emerge stronger.
