Here’s Why Chipotle Mexican Grill’s Revised Guidance Does Not Impact Our Price Estimate

After its Q1 2017 results, Chipotle Mexican Grill (NYSE: CMG) appeared to be on a recovery path. With rising revenues (probably a result of higher customer confidence) the company was able to gain from operating leverage and costs, as a percentage of revenues, were beginning to decline. It appeared that the company will need to spend less on food safety and promotion measures as it moves forward with customers returning to its stores after a significant impact due to the E. coli food virus. However, recent guidance issued by the company indicates that it will spend more on marketing and promotion and these expenses are likely to increase by nearly 0.3% going forward.  Food costs are likely to remain high although Chipotle expects same store sales to remain in the high single digits. The company’s expansion strategy is intact and it is likely to open 195-200 restaurants in 2017. This revised guidance comes after the company confirmed that a payment card security incident had impacted most of its 2,250 restaurants. (Read Data Breach At Chipotle: A Lesson For Restaurant Companies ?) While the revised guidance has led to a sharp decline in the company’s stock price it does not impact our price estimate for the company. While we revised the beta to reflect a lower discount rate for the company after the Q1 2017 results, since it is on a long term recovery path, we did not change our cost assumptions.

See Our Complete Analysis For Chipotle Mexican Grill

According to our estimates, Food, Beverage and Packaging costs will be around 34.5% of the revenues in 2017. This is 0.5% lower than last year and we expect a steady decline over the years as the company recovers from the E. coli food virus.

Similarly, we expect Adjusted Labor, Occupancy and Other costs to decline gradually over our forecast period as operating leverage kicks in and comparable sales increase.

Marketing and promotion costs are a part of the other operating costs of the company. We expect these total expenses to decline from 45.2% of revenues to 42.7% of revenues by the end of our forecast period. A slower rate of decline in these expenses can lead to a downside in our price estimate. However, a 0.3% increase in marketing and promotion costs will not impact our estimate significantly. If the total Adjusted Labor, Occupancy and Other costs are 46% of total revenues in 2017 (instead of 45.2% as per our estimate) and then decline gradually to reach 43.5 % (instead of 42.7%) by the end of our forecast period, there can be a less than 5% downside to our price estimate.  Our current price estimate for Chipotle Mexican Grill is around 4% higher than its market price and we will wait for the results of the next quarter to update our model.

We believe Chipotle is on a slow recovery path and while the company currently needs to spend more on marketing and promotions to attract customers, these costs should eventually decrease, and with higher revenues operating leverage should kick in. In the current competitive pressures with several “junk food” restaurants now transforming themselves into fast casual dining places with healthier menu options, Chipotle needs to invest more in wooing customers back, especially after its payment security incident. While this can impact profitability in the short term, our long term view on the company remains positive.

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