Growing Pains for Chipotle
The slump in the restaurant industry seems to be catching up with the hot Mexican chain Chipotle Mexican Grill (CMG), whose shares got crushed on Feb. 15 after its fourth-quarter earnings per share fell one penny short of expectations.
By normal standards, the profits that the Denver-based restaurant chain reported after the market close on Feb. 14 were robust -- growth of nearly 61% in the last three months of 2007 and of 66.4% for the full year.
But robust doesn’t cut it when the Street’s expectations keep ramping higher based on the company’s impressive track record since its vaunted initial public offering two years ago.
Chipotle posted a fourth-quarter profit of 53 cents per share, including a one-cent non-recurring tax charge, vs. 33 cents a year ago. Revenue jumped 31.5% from a year ago to $288.9 million, thanks to new restaurants that weren’t in the comparable number a year ago and a 10.6% rise in sales at locations open at least one year.
Improved labor efficiency and hikes in menu prices related to adding naturally raised meats in selected markets helped boost profits, while general and administrative costs dropped from 7.6% to 7.1% of revenue in the latest period, mainly as a result of efficiencies of scale from higher restaurant sales.
Earnings for all of 2007 came in at $2.13 per share, compared with $1.28 per share in 2006, based on a nearly 32% jump in revenue to $1.09 billion.
Investors who have become used to the company easily surpassing market projections hammered the stock, which fell as much as 12% on Feb. 15 before bouncing back to close 3.1% lower at 105.25. (The stock hit a high of 155.47 on Dec. 31, 2007.) The recovery from the day’s lows suggested investors were heeding analysts’ advice to view the selling pressure as an opportunity to buy a stock with strong long-term potential.
"This is finally the first quarter where the company didn’t materially exceed expectations, followed by higher sales and earnings expectations" for the coming year, says Robert Derringer, an analyst at Morgan Keegan in Nashville, Tenn. "This is the first quarter where we have to trend our numbers rather than increase our expectations."
He concedes that he and other analysts got too far ahead of themselves in their projections not only for the fourth quarter but for 2008 and 2009 as well, he said. (Morgan Keegan seeks to do investment banking business with the companies it covers in its research reports.)
Wall Street is projecting earnings of $2.72 per share for all of 2008.
On the conference call it held to discuss the results late Thursday, Chipotle said it was comfortable with earnings growing at around 25% annually over the next few years.
Derringer, who rates the stock market perform, said he trimmed his 2008 estimate by 10 cents to $2.72, which would be 27% higher than the 2007 results, a sharp drop from earnings growth of 66% in 2007 and 94% in 2006.
"Given that the trend isn’t quite as strong and not as overall compelling as it has been in the past, we’re going through an adjustment on the Street," he said.
The market may be concerned about the prospect of weakening comparable sales growth in 2008. Chipotle says it sees same-store sales rising in the low- to mid-single digits this year. But it expects customer traffic to continue to be positive, unlike much of the restaurant industry, said analyst Dean Haskell in a Feb. 15 research note for Morgan Joseph & Co. (Morgan Joseph intends to seek or expects to receive compensation for investment banking services from Chipotle within the next three months.)
"While Chipotle is hesitant to take price increases outside of covering Food with Integrity costs, management expects to do so if commodity-driven margin compression occurs," the note said.
David Tarantino, an analyst at Robert W. Baird & Co., upgraded the stock from neutral to outperform, and kept his 2008 earnings forecast at $2.68 but indicated this number could be raised. He said the company could earn as much as $3.10 per share this year if it can keep comparable sales growing at more than 10%. His price target is 140.
Chipotle’s margins narrowed in the fourth quarter partly because of higher labor costs. For 2008, the company said it doesn’t expect to see a slowdown in rising commodity costs, most of which will be associated with higher cheese prices. While Chipotle isn't contracted for meats, since it aims to use naturally grown meats instead of commodities, it says it would have to raise prices by just 1.5% in order to offset higher food costs this year, according to Haskell, who has a hold rating on the stock.
"They compete somewhere between fast food and casual dining," says Derringer at Morgan Keegan. "The value in that [market] is one that clearly appears to benefit in tough economic times" as consumers scale down their dining choices to more affordable venues.
Even though he believes the restaurant industry has been in a recession for the past six to nine months, Derringer thinks Chipotle will continue to do better than most of its peers. He predicts the stock will continue to trade at a lofty price due to its operating strength.