Can The Mexico Tax Be Another Big Blow To Chipotle Mexican Grill?
As President Trump seeks a 20% Mexico import tax to pay for the proposed border wall, Chipotle Mexican Grill (NYSE: CMG), which imports avocados from Mexico (exclusively in certain months of the year), is likely to face an increase in its raw material cost. Avocados are the most important ingredient for guacamole, which is a significant menu item for Chipotle. Each Chipotle restaurant consumes around 3,750 pounds of avocados every month. The company operates nearly 2,200 restaurants which makes its monthly avocado consumption to be 8.25 million pounds. Even if three months’ worth of consumption is imported from Mexico it would account for nearly 25 million pounds of imports. However, some analysts estimate that Chipotle gets around 70 million pounds of avocados from Mexico every year. A 20% import tariff would make avocados costlier for the company, impacting its margins negatively. The company will find it difficult to pass on this additional cost to its consumers given that it is already reeling under the E coli food virus problem and looking at ways to build its reputation and attract customers back to its stores. An increase in the price of guacamole might not go down well with its customers.
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Guacamole is key part of Chipotle’s brand image and discontinuing this “extra” menu item might not be an option for the company, especially at a time when it is working to revive its image. According to Chipotle, every $10 per case price movement up or down on avocados impacts its earnings by 17 cents a share. In the first half of 2016 the company paid $30 per case for avocados. However, this figure jumped to $80 a case in October 2016 due to a shortage. While the company expects this number to fall in 2017, a 20% tax can impact the price per case by $10 (assuming the price equilibrium is reached at $50 a case), impacting its earnings per share by 17 cents. If the company continues to pay $80 per case this impact can be around 25 cents.
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We estimate Chipotle’s earnings per share to be around $ 8.17 for the calendar year 2017. A 17-25 cents decline in these earnings will not impact Chipotle’s stock price significantly. However, in a scenario where commodity inflation raises its food costs to around 35% of its revenues as opposed to our estimate of 31%, we expect the earnings per share to decline to $5.66 leading to a nearly 20% downside in our price estimate.
The proposed Mexico tax is likely to impact Chipotle’s margins negatively at a time when it is struggling to grow revenues and working on a high marketing budget. While this impact might not be very significant, it comes at a wrong time for Chipotle as the company is already struggling to grow its earnings per share.
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