Rising Avocado Prices And Chipotle’s Other Woes

As Chipotle Mexican Grill (NYSE: CMG) struggles to improve sales, its costs are spiralling due to the increase in avocado prices. Surging demand and a smaller crop in Mexico and California have impacted the price significantly and it is likely to remain high for the rest of the year. Avocado is the main ingredient in Chipotle’s popular guacamole and with a more than 70% increase in prices compared to last year the company’s margins are likely to be impacted. The chart below shows how Hass Avocado prices have trended in 2017 and a comparison with previous years:

This price increase has been due to a shortage in supply and a significant increase in demand since several restaurants are now introducing avocado based menu items, including the avocado toast offered by Starbucks. One large yield of avocados depletes the soil of resources resulting in a smaller harvest the next year. Thus, the avocado supply falls short of demand every other year leading to higher prices. For Chipotle, which is already struggling to grow customer traffic, higher food costs would impact margins. In the Q2 2017 earnings call Chipotle management mentioned that short supply of avocado impacted its food costs by 140 basis points compared to last year and by 70 basis points compared to the last quarter. These higher costs offset the savings made by the company by reduction of food wastage, lower packaging costs, and changes in food safety procedures.  From Q1 to Q2 2017, the company’s food costs increased by 30 basis points due to higher avocado prices and stood at 34.1% in Q2 2017.

According to our estimates, Chipotle’s food costs as a percentage of revenues would be around 34.2% in 2017 and we expect this number to decline gradually over our forecast period as revenues grow and operating leverage is achieved.

However, if rising avocado prices keep these costs high there can be a downside to our price estimate.

While Chipotle’s margins can be impacted due to spiraling food costs, the company’s immediate focus should be to attract customers back to its stores. With a significant reputation loss as the company suffers from food safety incidents, driving revenues by increasing comparable sales is crucial for Chipotle. Higher food costs can impact margins to some extent, but lower revenues can impact the company more significantly. Rising avocado prices is a concern, but not as big as declining traffic.

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