What Really Changed?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I never cease to be amazed by this market. What is really unbelievable is when a company tells you what's going to happen, repeats the same information again, and then the shares are decimated when it delivers on what it promised. The most recent example of this is Chipotle (NYSE: CMG). The company reported earnings, that in many ways were better than what people were expecting. However, one number, same-store sales growth, was the downfall of the stock. With shares trading at over $400 before earnings, and trading at just over $300 today, this over 20% discount occurred because the company over delivered on its promises.
In the fourth quarter of last year, the company said that it expected mid-single digit comparable store sales growth next year. In the company's April 19 earnings release, the company again said it expected mid-single-digit comparable store sales growth for the full year. This earnings report, Chipotle delivered comparable sales growth of 8%. In my eyes, mid single digit means around 5% growth. So as you can see, the company delivered better than forecasted comparable sales growth, and yet the market acted as though Chipotle never said anything of the sort. Investors should take note, that the company said in this earnings report as well, that they expected mid-single-digit comparable sales growth. Since comparable sales were actually above the company's estimates, it should be no surprise that Chipotle outperformed on multiple other measures as well.
The company's total revenue was up 20.9%, operating margin came in at 29.2%, and diluted earnings per share were up an astounding 61%. This earnings-per-share performance of $2.56 handily beat their average analyst expectation of $2.30. In addition, operating margin was 3.4% better than last year. The company also opened 55 new restaurants, bringing their total count to 1,316. In addition, Chipotle kept with their previous guidance of 155 to 165 restaurant openings for the year. Going back briefly to the company's same-store sales, one factor that investors should be aware of is that average restaurant sales have actually increased every quarter for the last five. For example in June of 2011, the average restaurant sold $1.927 million. By June 2012 the average restaurant's sales were up to $2.106 million. None of the above numbers indicates the company that are struggling in any way, shape, or form, yet investors are acting like the company missed earnings by a mile. You might be asking, what about the company's financials? Maybe there was something on the financial statements that scared investors, and that was the real reason the stock sold off.
Where Chipotle's financial statements are concerned, we know that net income was not an issue as this number beat most expectations. Looking at cash flow, net income plus depreciation increased 38% year-over-year. What was confusing to me at first was the company's operating cash flow total. The line item, “excess tax benefit on stock-based compensation” presented a problem until I did a little research. This line item is a non-cash expense, that has a direct offset under the cash from investments section of the cash flow statement. The number represents the amount of profit that employees make when they exercise their stock options. The company is allowed to write off this profit on their tax bill, as it's considered employee compensation and is tax-deductible. As you can see, the company does not spend actual cash, yet this line item decreases the companies reported operating cash flow. Without this adjustment, at first investors could mistakenly believe that the company's operating cash flow declined slightly. However with this adjustment, the company's operating cash flow actually increased nearly 20% on a year-over-year basis. Investors need to be aware that cash flow growth did not keep up with net income growth. Without this adjustment, investors could see trouble where there actually is none. I've noted in the past, that the company has a higher pretax margin than their competitor Buffalo Wild Wings (NASDAQ: BWLD). The company also has net income per employee that is nearly triple that of Yum! Brands (NYSE: YUM). I make these points, because I've made the mistake myself of assuming that I could value Chipotle based on its traditional P/E ratio. However, this is not the most effective way to compare the company to other restaurants. The P/E ratio doesn't account for the fact that Chipotle is much more efficient than most of their competition.
Speaking of competition, each of the aforementioned competitors could be seen as an alternative investment to Chipotle. Buffalo Wild Wings is a smaller restaurant chain that is expected to see sales growth in the next two years that would exceed analysts expectations for Chipotle. Both companies have similar long-term EPS growth estimates as well. Even with the current drop in Chipotle's stock, the company is still valued at a forward P/E ratio of about 35, compared to roughly 24 at Buffalo Wild Wings. Where Yum! Brands is concerned, the company is in a different league from Chipotle and not necessarily in a good way. Yum! Brands is expected to see earnings growth of less than 14% in the next several years. In addition, Yum! Brands revenue growth is expected to be about half of Chipotle. With both Buffalo Wild Wings and Chipotle expected to grow earnings at over 20%, Yum! Brands can't possibly show investors the same type of growth. Many people said that Chipotle looked like an attractive investment before this earnings report. In a strange way, the stock has to look even better today. For those looking for a more reasonably priced company with a similar growth rate, Buffalo Wild Wings would be my choice.
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, Chipotle Mexican Grill, and Yum! Brands. 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.