Image Source: Mike Mozart
The once beaten down fast casual restaurant chain Chipotle is back to delivering solid comparable restaurant sales growth thanks to menu price increases, and restaurant level operating margin expanded significantly as lower marketing and promotional spending was required to appease cautious consumers.
By Kris Rosemann
Simulated Best Ideas Newsletter portfolio idea Chipotle (CMG) reported 8.6% year-over-year revenue growth in the third quarter of 2018, results released October 25, driven by new store openings and a 4.4% increase in comparable restaurant sales. Average check moved higher from the year-ago period due in part to a 3.8% effective menu price increase but was partially offset by a 1.1% decline in comparable restaurant transactions. This weakness in traffic was roughly in-line with an industry wide decline of approximately 1%, according to NPD, and management noted on its third quarter earnings call that traffic was roughly flat to start the fourth quarter of the year, a slight improvement that will only help drive comparable restaurant sales higher as it continues to reap the benefit of recent price hikes.
Chipotle’s restaurant level operating margin expanded 260 basis points in the third quarter from the year-ago period as higher comparable restaurant sales and lower marketing and promotions spending was partially offset by increased repairs and maintenance and labor inflation. Food, beverage, and packaging costs came in at 33.4% of revenue in the quarter, a 160 basis point decrease from the third quarter of 2017, which was driven by menu price hikes and lower avocado costs while higher beef, paper, and packaging items added to spending levels. Net income nearly doubled in the third quarter to $38.2 million from $19.6 million in the year-ago period, and earnings per share made a similar leap to $1.36.
The company is a solid free cash flow generator, and the measure advanced 32% on a year-over-year basis in the first three quarters of 2018 to more than $282 million. This growth came despite a 27% increase in capital spending from the year-ago period. Chipotle’s balance sheet remains debt free as of the end of the quarter, and cash and cash equivalents of $343 million, up from $185 million at the end of 2017, provide it with ample financial flexibility as it continues to grow its store count and invest in growth initiatives.
Expanding its digital system is a key priority for Chipotle as it battles with other fast casual chains to provide the most convenient experience for its guests. In the third quarter, digital sales accelerated from first half 2018 growth rates to 48%, and digital sales accounted for 11.2% of total sales in the period. The company continues to invest to remove friction from the digital ordering and pick-up process, including a separate digital make line, digital pick-up shelves, and a number of restaurants having a drive-up window for digital orders, in addition to working to expand its delivery time advantage.
Management reiterated its guidance for 2018 comparable restaurant sales growth to be in the low- to mid-single digits, and new restaurant openings are now expected to be at the lower end of its 130-150 guidance range before growing to 140-155 new restaurant openings in 2019. All things considered, we were pleased to see solid top-line growth and margin expansion at Chipotle in the third quarter, though traffic trends could be better and are worth watching. Higher average check and lower marketing and promotional spending were encouraging developments with respect to margin performance, but rising labor costs and potentially volatile food, beverage, and packaging costs have the potential to pressure margins in the future.
Nevertheless, we continue to highlight Chipotle in the simulated Best Ideas Newsletter portfolio, albeit at the lowest-possible weighting. Our fair value estimate currently sits $459 per share, but if the company is able to continue improving its margin performance along with ongoing comparable restaurant sales growth, the latter of which should only be boosted by its digital initiatives, the higher end of our fair value range may very well be in play.
Restaurants – Fast Food & Coffee/Snack: ARCO, DPZ, DNKN, JACK, MCD, PZZA, SONC, SBUX, WEN, YUM
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.