Chipotle Mexican Grill Earnings: Pork Shortage Slows Down Comparable Sales Growth
Chipotle Mexican Grill (NYSE:CMG) is off to a flying start in 2015, as the company reported strong numbers in its first quarter earnings report for the fiscal 2015. Chipotle’s net revenues for the quarter rose 20.4% year-over-year (y-o-y) to $1.09 billion, with comparable store sales rising 10.4%. 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. The company’s net income rose 47% y-o-y to $122.6 million, resulting in an increase of 160 basis points in restaurant level margins to 27.5%. As a result, Chipotle managed to report diluted EPS of $3.88, up 47% y-o-y. [1]
The company expects to open 190-205 net new restaurants in the fiscal 2015, with a low-to-mid single digit comparable sales growth.
We have a $669 price estimate for Chipotle, which is less than 5% above the current market price.
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Slowing Comparable Store Sales Growth
In Q1 2015, Chipotle reported an impressive comparable store sales growth of 10.4%, as the company increases average transactions by 21 throughout the day. However, this figure is compared against the 13.4% comparable store sales growth in Q1 2014, and as a result, despite the strong financial result, Chipotle’s stock (CMG) slipped more than 7% in the first trading hour on April 22. According to the company, the slowness in comparable store sales growth is partly due to harsh weather conditions in the U.S., affecting some of the important Chipotle markets, and partly due to some operational decisions, such as the decision to stop the service of Carnitas is some of the company’s stores.
In January, the company suspended one of its pork suppliers in the U.S. after a recent audit, on claims of below standard animal welfare protocols. This affected the supply of Carnitas to about one-third of the company’s outlets. However, the decision of the company to not shift to pork from conventionally raised pigs went down well among the customers. Moreover, Chipotle uses meat that comes from animals raised in natural environments and without the use of antibiotics. According to the company’s research, the number of people who prefer to eat locally grown food has increased over the last three years.
In this scenario, the company is facing short-term supply constraint in terms of pork supply. Despite the effort of the company’s long-term suppliers to increase the output of reasonably raised pork, Chipotle might face a pork shortage at more than one-third restaurants during the peak spring and summer months. Moreover, the company believes that the comparable store sales might have been 100 to 200 basis points higher in case of normalized weather.
Chipotle expects the comparable store sales in the second quarter to be in the low-to-mid single digits, with as much as 200 basis points negative impact due to the pork shortage.
New Store Openings In-line With The Guidance
Chipotle opened 49 net new restaurants in the first quarter including one ShopHouse Southeast Asian Kitchen restaurant, compared to 44 during Q1 2014. Chipotle’s total store count reaches 1,831, which includes 10 ShopHouse stores and 2 Pizzeria Locales. These two new growth concepts are designed on a similar model as that of Chipotle, and are in their early stages of development. In the first quarter, the company’s average sales volume crossed $2.5 million per restaurant for the first time.
The company is focused on entering into new markets and has plans to introduce Pizzeria Locale in Kansas City and Cincinnati later this year. With other top fast food chains keen on expanding internationally, Chipotle might look forward to accelerating its store expansion in high GDP countries in Europe and Asia, as well. There is a lot of potential growth for the company in these markets, where the concept of fast casual dining is already catching up, and customers might love to have one of the top chains of this new category in their country.
Lower Food Costs and Labor Costs Drive Margins
Chipotle witnessed a decline in food costs from 35% in the fourth quarter to 33.9% in the first quarter of 2015. This is primarily due to the favorable prices of dairy products and avocados. Slight increase in supply of avocados helped Chipotle in keeping the prices reasonable during the first two months of 2015.
On the other hand, beef prices pressured the company’s margin growth, but Chipotle managed to still post restaurant level operating margins of 27.5%, up 160 basis points y-o-y. Chipotle expects beef prices to remain elevated during the entire year, and as a result might raise the prices on steak and barbacoa by 4-6% by the end of third quarter. Chipotle expects the seasonal shift in avocado market to create problems in the next two quarters.
Additionally, General and Administrative expenses were 5.8% of the sales in the quarter, down from 7.4% last year. Both the labor costs and marketing expenses were down compared to first quarter last year. However, the company believes that its marketing costs might increase during the second and the third quarter.
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