- Although a loss was reported (first time in the young company's history), Chipotle is going to invest aggressively through this cycle.
- Even if margins don't recover to earlier levels and the average earnings multiple drops, this stock is worth $500+ if it achieves 2017 estimates.
- Chipotle will be prudent where it opens its restaurants in 2016. Same store sales will keep rising in 2016 due to trust being won back.
Chipotle Mexican Grill (NYSE:CMG) reported its first ever loss in its first quarter earnings last night since the company went public in 2006. I outlined in my earnings preview that I expected it to be bad, and bad it was although the fast casual chain beat earnings estimates (-$0.88 compared to -$1.05 predicted). The problem was definitely same store sales which decreased by almost 30% compared to the 28.4% number previously predicted by analysts. To give you some idea of the carnage ongoing health concerns have caused, top line sales in the first quarter last year came in at $1.09 billion, but Chipotle was only able to muster $834.5 million this quarter. That's a drop of 23%, and since investment is going to stay elevated (through new store openings, safety protocols and marketing costs), things may end up getting worse before they get better. The stock sold off by over 4% in the after-market trade after earnings were released and many analysts now believe that we will see sub $400 prices in the near term. This assumption may turn out to be true but with the share price now down almost $340 off its all time highs, I'm still quite bullish on this stock especially when you take into account the investment management is prepared to commit right through this down cycle.
Firstly, investors have to remember that the company was unlucky when the Boston noro-virus news hit the press last month because sales were improving at that point. Therefore, it is imperative that no other "incidents" take place in the next few months as sales and earnings projections will be adversely affected. Presently, the street is predicting an EPS of $1.59 for next quarter's earnings and $6.12 for the full year. Projections have been falling steeply for the last few months and they have to turn upwards for the street to value the stock differently.
I repeat - it's not about the present comps numbers that will move the stock - it's all about the pace of the sales recovery. For example, Chipotle stock went from $58 at the end of 2008 to $715 at the end of 2014 which is a 12 fold increase. Earnings per share during this time period went from $2.36 to $14.13 which is a 6 fold increase. Now analysts are projecting $13.20 in earnings in 2017 which would give a modest earnings multiple of 37 if the stock traded at $500 per share (17% increase from last night's closing price). Chipotle's 5 year average price to earnings ratio is 46 and ten years average is 42 which makes me believe that if the company can achieve next year estimates, it will trade for at least $500 a share as I have incorporated a sizable drop in its average earnings multiple which I believe won't be penetrated.
I would also say that just because Chipotle's recovery is undoubtedly taking longer than "Jack in the Box" and "Taco Bell" doesn't mean the fast casual chain can't make a full recovery by the end of 2017. Chipotle's market conditions are entirely different this time around which is why the recovery will be a long drawn process. Why? Well, social media for one means that far more people can become informed (Jack in the Box didn't have this problem in 1993). Furthermore, the ongoing investigation being carried out by the Department of Justice is definitely affecting matters and newly implemented safety measures still haven't made their mark yet.
Yet Chipotle is still going to charge ahead in 2016 by planning to open 220 to 235 new restaurants this year which illustrates the faith the management has in its ability to get sales comps back to former levels. Here is where investors need to focus. There is no doubt that Chipotle will keep growing its top line. With top line sales predicted to drop to $4.23 billion this year (down from $4.5 billion in 2015), revenue is expected to reach $5 billion in 2017, which would be a record for the company. However, it is operating margins (17.3% printed in 2014) where bears feel Chipotle won't recover. I disagree.
Firstly look at where margins are coming under pressure at the moment. You have elevated marketing ($50 million spent in the first quarter), new safety protocols, burrito coupons, legal and labor costs. All of these expenses are temporary in my view which will slowly taper off as sales comps recover. Furthermore, the aggressive store opening plan will also bring something to the table. Chipotle will now probably be more conservative with where it opens its new restaurants, which should help supply chain due to new units being close to proven suppliers.
To sum up, Chipotle actually beat earnings per share estimated but the leak of the Boston noro-virus incident hurt sales comps at the back end of the quarter. The stock now looks like it will hit $400 which would make it a strong buy in my opinion. Why? Well, current margin pressures will end up being temporary and recent health scares will mean the fast casual chain will consolidate for a while by opening up its new 2016 restaurants in locations that are as low risk as possible. Once trust is won back, the street will value this stock differently.