What To Watch Out For In This Chipotle Mexican Grill, Inc. Earnings

  • Continued decline in same store sales growth and slower new restaurant openings due to food safety.
  • Financial impact of promotions to bring back customers into stores.
  • A large share buyback to increase the likelihood of stock awards for executives.

Chipotle Mexican Grill's (NYSE:CMG) Q1 earning release on April 26th, 2016 may be the most important release the company will ever have. Following a devastating e-coli outbreak that sickened numerous customers and led to a nationwide closing of stores, the company's once envious brand name became synonymous with food poisoning. The share price dropped from $750 in October to less than $500 today.

What should investors look for in the upcoming earnings release?

Chipotle Operating Metrics

Prior to Q4 2015, Chipotle's investors were accustomed to consistently increasing same stores growth and average restaurant sales. Since the IPO in 2006, through the financial crisis and the subsequent recovery, Chipotle increased same-store sales year over year, every year.
 Chipotle Fiscal Year Same Store Sales Growth

This trend continued in 2015 until the food safety concerns and related store closures began in October. In Q4 2015, Chipotle experienced it's first quarterly decline in same-store sales growth. The company announced that sales declined 30% in December, followed by a subsequent 36% drop in January and another 26% drop in February 2016.

Chipotle FY 2015 Same Store Sales Growth

Investors are already expecting a decline in same-stores sales for Q1 (sales were down in 2 of the 3 months) and will focus on March data. The re-opening of all stores coupled with an aggressive marketing campaign to bring back customers will raise questions like, did the company reverse course and increase sales in March? Or is the Chipotle brand name still tarnished? And are sales still declining?

In the 2015 earnings release in early February, Chipotle stated that it was planning to open between 200 and 235 new locations in 2016 compared to 229 in 2015. The company currently has 2,010 restaurants worldwide. The expansion plans disclosed in February would increase the number of locations globally by 10%. If customers are not returning to Chipotle, will the company slow down new store growth?

Chipotle's Promotional Costs

In early February, Chipotle announced a massive promotional program to bring customers back into their stores. The company said it would give away $70 million of free burritos via mobile coupons and would also send out 21 million direct fliers for free burritos. The total promotional cost is currently expected to be over $120 million. This does not include the free chips and guacamole give away occurring in parallel.

If Chipotle is unable to increase sales in March with the heavy promotional spending, how will the company react? Will they further increase promotional spending? Launch a different campaign?

Based on the company's Q4 2015 income statement, the large (and hopefully one time) promotional expenses may lead to Chipotle's first-ever quarterly loss. In Q4 2015, the company had an operating income of $103 million. The marketing spend coupled with drastically lower sales in January and February may lead to an operating loss when one-time items are included.

Financial Engineering To Boost CEO Pay?

Chipotle has long been criticized for what critics have called excessive CEO compensation. Steve Ells and Monty Moran, the company’s co-founders, are co-chief executives and earned a combined $57 million in 2014. During the previous year, 2013, the combined pay package for the two executives was $67 million; 10 times higher than that at peer companies, according to the Denver Post. At the 2014 annual meeting, in a non-binding vote, 77% of investors rejected the company’s executive pay package.

Following the e-coli, salmonella and other food safety concerns in late 2015, the combined compensation for Ells and Moran was cut 51% to $27.4 million. In an SEC filing on March 11th, the company stated that new option awards for executives would be conditioned on the stock price trading above $700 for 30 consecutive days.

With the stock now trading at less than $500, will the company undertake financial engineering to increase the price?

Chipotle’s has not completed a large share buyback since going public in 2006. Will a large buyback be announced to boost the stock price?

If a buyback is announced investors should question the intent. Is it to buy shares at depressed prices? The stock is down 35% from its 52 week high and the board may believe it’s undervalued. Or is the buyback being completed to boost the stock price and trigger executive option awards?

Conclusion

Chipotle's quarterly earning release on April 26th may be the most important earnings release the company will ever have. Food safety concerns led to three straight months of declining same-store sales. A new incentive package was launched that may encourage stock buy backs to boost executive pay. Large promotional spending may lead to the first ever quarterly loss for the company when one-time items are included. New store growth may have to be slowed down due to declining sales. These are some of the key data points investors should look for in the earnings release.

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Comments on this article and CMG stock

KALVES03
bearish
FORGET IT--FOOLS GOLD THIS QUARTER--STOCK IS GOING TO BE BELOW 400.00
reply
user profile picture
harshal.patel.1
bearish
Since Same Store Sales data for Jan and Feb are already released, March would have be to incredibly bad for a drop that large. I'm assuming the bad data from Jan/Feb has already been priced in.

Regardless, I'm sticking with KR for the long run and nothing else.
Do share this awesome post