Chipotle Mexican Grill: Increased Competition From Taco Bell Taking a Toll
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Chipotle Mexican Grill (NYSE: CMG) reported its second quarter earnings after the close of the market on 19th July and the stock price has taken a beating with a staggering 21% drop in just a single day. Looking just at price movements, one would expect Chipotle’s earnings results to be horribly bad. But that was not the case, as the company's reported Q2 earning per share were $2.56, 61% more than the prior year and 11% more than the consensus estimates of $2.30. Net income of $81.7 million represented a massive 61.2% rise year over year. The company also reported an impressive 340 basis points of margin expansion (reported restaurant level operating margin of 29.2%).
But strong Q2 EPS was overshadowed by a SSS shortfall, which reflected deceleration in core traffic fundamentals. The company’s 8% SSS growth missed the 9.4% consensus estimate by a fair margin. April SSS were up 10.0%, but trends slowed in May and June. July traffic trends remain at similar levels as the end of the second quarter.
CMG maintained full-year guidance for same restaurant sales (mid-single-digits growth) and unit growth (13.8% in 2012). While food costs have been better than anticipated so far in 2012, management still sees potential for inflation to emerge late in the year and into 2013; we believe CMG retains adequate pricing power to address inflation.
Yum! Brands (NYSE: YUM) owned Taco Bell seems to be providing tough competition for Chipotle and gaining consumer traction. Taco Bell’s SSS in the first quarter were in high single digits as compared to Chipotle’s 12.7%. With the successful launch of the Doritos Locos taco, the introduction of the Cantina Bell menu, and the continuous roll-out of breakfast, Taco Bell has drastically improved its consumer base and posted a 13% SSS growth (versus Chipotle’s 8%) in the second quarter.
Going forward, Chipotle has no plans to increase pricing in the next couple of months. So without a significant improvement in traffic, same restaurant sales could slow down to the 3.5%–4.0% range during the back half of the year. SSS at this level could adversely affect EPS growth and are likely to compress a still high P/E multiple of 28.9x. So we are downgrading our rating on the stock to Sector Perform.
That being said, Chipotle still remains one of the best long-term stories in the restaurant sector as the company possesses one of the strongest mixes of unit expansion, SSS gains, and industry-leading restaurant margins in the space. The company sports industry-leading returns, as well, with huge potential for growth with its core Chipotle brand and possibly also from the promising Shophouse brand. So, we wouldn't write off the company completely. We would be closely watching for some stability/improvement in SRS to become positive on the stock again.
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