Rising Food Costs Put Chipotle in a Precarious Position

Chipotle Mexican Grill, Inc (NYSE:CMG) may find it hard not to pass on the rising costs to consumers this year as rising food prices are affecting its profitability. Chipotle doesn’t plan to increase the menu prices this year and lower margins are bound to put a downward pressure on the stock price. Chipotle had a stellar 2011 and returned close to 60%, its growth besting the growth of peers such as Chili’s, McDonald’s (NYSE:MCD), Burger King, Yum! Brands (NYSE:YUM) and Papa John’s, among others.

See our complete analysis for CMG stock here

Menu Price Imbroglio

According to Barclays Capital, Chipotle expects the commodity inflation to be more than 5% in 2012 but the company doesn’t plan to increase the menu prices. ^[1] Food cost, as a percentage of total costs, rose 2.5% last quarter and now constitutes 33.1% of the total costs. Earlier in 2011, most restaurants expected food inflation to stabilize in the second half of the year but now expect to continue into 2012. Since most restaurants plan to increase the prices moderately this year, this could benefit Chipotle as the Average Number of Visitors is set to rise by our analysis.

But this is impacting its EBITDA margin. Since 2010 the company’s EBITDA margin has been decreasing, and we expect it to decrease for another year. Chipotle is also under labor cost pressures due to the probe of illegal immigration at several of its restaurants.

If the company does decide to increase menu prices to maintain profitability, the number of visitors might not increase at the desired rate which will again put a downward pressure on the stock price. Also, increasing the prices can negatively affect the Average Spend per Visit (ASV) as higher menu prices don’t necessarily translate to higher spend.

Tough Times Ahead

Chipotle’s net income rose almost 25% last quarter (Y-o-Y) which partly fuels the ebullience and speculation surrounding the stock. But this figure included a one-time price rise of 4.5% and since the company does not plan to increase the menu prices soon, the net income might not grow at the same rate in the coming time. ^[2]

The current market price of $348 looks overvalued. Although the company has performed exceptionally well with net income growing at a healthy rate each quarter, the rising commodity prices may spoil the party. The global recession saw the commodity prices plummeting which ensured healthy margins for Chipotle. Going forward, the company will face a difficult time, as it will have to do a fine act of maintaining profitability and not deterring existing and potential customers.

We have a $321 price estimate for Chipotle, which is about 5% below the current market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Restaurants plan for commodity inflation, menu price increases, NRN.com, December 27, 2011 [↩]
2. Chipotle Quarter Profit Gains 25% as Restaurant Traffic, Menu Prices Rise, Bloomberg, Oct 21, 2011 [↩]