Chipotle Mexican Grill, Inc. Q1 2016 Earnings Preview

  • If the marketing initiatives and free burritos are pulled in the near future, will sales be adversely affected in a big way?
  • Buybacks supports earnings temporarily but investors want to see growth initiatives such as new stores and ways of re-building of its brand.
  • Investors are interested due to 2017 expectations so they will be mindful of issues that could affect profitability next year.

Chipotle Mexican Grill (NYSE:CMG) announces its first quarter earnings on the 26th of this month and the question that remains topmost on investors' minds is whether the brand has been permanently damaged and if it can bounce back to levels of peer leading growth the company reported before the e-coli breakouts. One thing we know for sure is that this quarter will be horrible not just because of the estimated 30% lower sales this quarter but also because of the elevated marketing spend the fast casual chain had to embark on in order to restore its brand. Therefore the consensus EPS forecast of -$1.05 should be not that surprising when you combine the lower sales comps along with the $50 million that was invested in marketing and promotional activities. This quarter is going to be horrible but it will be the forward looking guidance that investors will be tuning in for. Many believe Chipotle will end up being a 2017 recovery story but that's still not a given at this stage. Here are some crucial areas, you should be watching out for when it reports on the 26th.

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There is no doubt that value investors are watching Chipotle closely. The company's earnings multiple is now hovering around the 30 level which is right at the industry's average even when we include the $300 drop in the share price since last October. Many investors still feel the fast casual chain has further to fall but one must remember that Chipotle's 5 year price to earnings average is 46.8 which reflects the growth Chipotle has delivered in recent years.  What made this company what it was before to the e-coli problems was its premium brand which fetched premium prices. In fact, Chipotle's net income went from $127 million in 2009 to $445 million in 2014 which mainly was a result of excellent traffic and transaction growth.
Now Foursquare, which is a location tracking firm, reported that foot traffic declined by 23% in the first quarter (compared to Q1-2014) which is a much healthier figure than the 30% decline in sales. The difference in the two numbers is basically from the millions of free burritos it is giving away through give-away coupons. Therefore, you can bet investors will be looking to see if the temporary freebies and huge marketing initiatives will have the desired effect in the long run. Can Chipotle recover its damaged brand and pricing power once those are taken away? Guidance for Q2 and Q3 will tell a lot of that story.
Furthermore, investors will be keenly observing whether the restaurant chain will be going ahead with its previous guidance of opening up 230 new restaurants in 2016. Chipotle must uphold its image of being a growth stock and the only way to do this is to drive through this downturn with courage and conviction. If Chipotle becomes a value stock, it will disinterest a lot of investors as the company currently doesn't even pay a dividend. If investors see strong guidance for restaurant openings along with strong share buyback programs (already being implemented), then this would definitely peak investors' interest.
The company definitely has the balance sheet to act aggressively. It had around $1.3 billion in cash on its balance sheet at the end of 2015 and by my calculations, it still would have enough cash to keep buying back shares at its current rate for another 4 to 5 months. Almost $800 million of that cash balance has been used already. I'm all in favor of buybacks especially when the stock is down over $300 from its highs, but if guidance for the top and bottom line improves, investors will want to see more investment back into the business. Share buybacks artificially improve earnings and can spike the stock, but long term growth investors will need to see earnings growth accompany any potential rise in the share price.
Long-term investors know that temporary e-coli and norovirus issues have been overcome by restaurant chains before (Taco-Bell & McDonalds (NYSE:MCD) to name but a few). Usually it takes a full 12 months for the chain to completely recover which is why 2017 estimates are so important. Analysts are projecting an EPS of $13.25 on revenues of $5.12 billion. Any issues the company currently has that could affect 2017 estimates will definitely sink the stock if these issues cannot be resolved in 2016. Analysts are hoping that the restaurant and operating margins will return to normalcy by 2017 (26.1% & 17% achieved in 2015) and they must, for Chipotle to stand any chance of remaining a growth stock in this industry.
To sum up, this quarter will undoubtedly be ugly but long term growth investors will be looking for trends and guidance across a host of metrics. Investors need to see that Chipotle can sustain a recovery when the punch bowl of free burritos is taken away for good. Furthermore, the number of new restaurant openings for 2016 must continue to remain elevated and margins must return for the fast casual chain to have any chance of achieving its 2017 EPS goals.
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