Chipotle Earnings – Beyond the Headlines
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Chipotle (NYSE: CMG) has been on fire recently. The stock has been about as hot as their burritos, and I've written in the past that I originally thought the stock was overpriced. However, that was before I really dug into the company's financials and realized, that part of the reason Chipotle is valued higher than its competition was its superior cash flow and revenue per employee versus other restaurants. The company just reported earnings and there were a few changes to the company's numbers that were impressive, and a few that gave me some indigestion.
First, as everyone knows the company reported revenues up 25.8% and EPS up 34.9%. One of the most impressive numbers on the surface was the company's 12.7% increase in comparable restaurant sales (comps.). In fact, this was at least the fifth straight quarter of double digit growth in comps. There is just one big problem, the company told us that 4.9% of this increase was from menu price increases. This means without these increases, comparables would have been up 7.8%. While a 7.8% increase in comps is nothing to sneeze at, it would have broken the string of double digit increases in the last 5 quarters. To further drive home the point, management said, “we do not expect additional menu price increases in 2012”. Long story short, it is possible that Chipotle will break this string of double digit increases in comps next quarter. Don't say I didn't warn you.
Second, the company ended the quarter with 1,262 restaurants. With at most 165 new restaurants, the company would see year-over-year growth in restaurants of 13.41%. If you add to this the 4-6% increase in comps. you get top line growth of 17.5%-19.5%. With the company expected to increase its earnings by 30% for the full year, management is going to need to push hard to make this top line growth create 30% EPS growth.
My prior article argued that Chipotle should be more highly valued based on superior cash flow generation. Well, this quarter there were a few blows to that theory. First, Chipotle needs to be careful about stock-based compensation. Last year this decreased operating cash flow by $8.9 million, this year it took a hit of $20.24 million. This one line item increased as a percentage of net income, from the high teens last year to over 30% this year. It's one thing to reward your employees for outstanding performance, it's quite another to more than double these awards in just one year. The second issue I saw was “other assets” changed from a positive $456,000 last year to a negative $9.9 million this year. This could be a one time adjustment or the beginning of a trend and bears are watching. The company gave no explanation that I could find about this adjustment. Third, an increase in the company's effective tax rate caused another adjustment of $5 million to operating cash flow. While the company can't do much about its tax rate, the other two items combined to cut operating cash flow from what would have been $50 million down to $29.37 million. This was significant because the company still spent $41.8 million on capital expenditures. To make up the difference, Chipotle drew about $30 million from their cash reserves. If these are one time items that is one thing, but the stock-based compensation wasn't presented as a one time occurrence, and investors need to watch this line item carefully.
If Chipotle continues to hand out stock-based compensation the way they did in this last quarter, some of the argument for buying the stock goes away. In the past I compared Chipotle's free cash flow per $1 of assets to popular competitor Buffalo Wild Wings (NASDAQ: BWLD). Chipotle at the time was generating $0.18 of free cash flow per $1 of assets over the last four quarters. Compared to Buffalo Wild Wings who was only generating $0.037 of free cash flow, this seemed like a logical reason to buy Chipotle even at a higher valuation. With Chipotle's most recent report, the last four quarters show $0.13 of free cash flow per $1 of assets. While this is still impressive, it represents a drop of 27.7% from just 3 months ago. If this trend continues Chipotle's competitive advantage will be out the window, and the speed of the decline in the stock price could be faster than the service at the restaurant. I'm not suggesting jumping out of Chipotle now, but I am suggesting that stock-based compensation is something to keep an eye on. Add Chipotle to your Watchlist to keep up with developments.
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Buffalo Wild Wings and Chipotle Mexican Grill. Motley Fool newsletter services recommend Buffalo Wild Wings and Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.