Chipotle: Earnings likely to stall as valuation risks are high. (NYSE: CMG)

Introduction and funding thesis

Chipotle Mexican Grill (NYSE:NYSE: CMG) operates eating places that serve burritos, burrito bowls, quesadillas, tacos and salads utilizing recent, high-quality components, and its inventory has outperformed the S&P 500 and Nasdaq 100 indexes year-to-date. The The corporate reported on its Revenue for the first quarter of FY24 April 24, as income and working revenue grew 14.1% and 20% YoY, respectively, pushed by quantity and transaction dimension progress from improved throughput, related model campaigns and menu improvements, as comparable restaurant gross sales elevated up 7.0% YoY together with 47 new eating places with 43 areas, together with Chipotlane, bringing the whole variety of eating places to three,479.

​​​​​​Whereas administration raised its forecast for comparable gross sales progress within the mid- and high-single digits, it additionally warned of probably larger prices of promoting inputs similar to like avocados, in addition to rising wage costs, which might harm short-term margins. ​​​​​​Whereas the corporate has thus far efficiently handed on shopper spending with out harming its progress prospects, I imagine that the weakening labor market and an unsure macroeconomic panorama enhance the danger of a pullback in shopper spending, which might harm Chipotle’s backside line and backside line. . . Moreover, investor optimism is at an elevated stage given the outlook for future earnings progress, which I imagine will increase the vulnerability to a major short-term value correction. With each “good” and “poor” scores, I imagine the short-term valuation dangers have outweighed the upside potential, making it a “promote” at present ranges.

Good Advantages: Robust Q1 income pushed by quantity and transaction dimension progress, elevated throughput and menu innovation driving buyer engagement, improved unit economics

Chipotle reported 1Q14 earnings by which income rose 14.1% y/y to $2.7 billion, pushed by a 7% y/y enhance in same-restaurant gross sales mixed with the opening of 47 new eating places and 43 Chipotlanes as the corporate noticed capability enhancements at its eating places. growing consciousness by way of profitable advertising campaigns and menu improvements, spotlighting Barbacoa and the return of Hen Al Pastor as a limited-time provide.

Throughout the earnings name, Brian Nichol outlined among the key methods which are serving to them win in a tricky macroeconomic surroundings, the place they proceed to expertise sturdy footfall, leading to 19% year-over-year in-store gross sales progress, in addition to progress of their digital presence. , with digital gross sales accounting for 37% of gross sales in Q1. On this publish, I am going to talk about the corporate’s three fundamental methods it makes use of to draw and retain its prospects so as to consider the corporate’s long-term funding.

The primary technique I would like to debate is the corporate’s concentrate on operating profitable eating places that serve nice meals and supply prospects with nice eating experiences and digital companies. Whereas the corporate prides itself on getting ready wholesome and scrumptious meals to the very best requirements, it additionally emphasizes its ubiquity, which continued to enhance by virtually two entrees in quarter-hour in comparison with final 12 months because it spends sources to raised prepare groups, permitting them to maintain up with demand with out stress. I imagine that the pace of service in eating places performs a vital position in bettering the standard of visitor service, and if the corporate continues to enhance its throughput, it is going to profit from larger transaction quantity in addition to decrease turnover, whereas buyer ready occasions are lowered, which permitting them to get scorching and recent meals sooner.

The second technique I would like to speak about is their go-to-market packages to create compelling and related model campaigns and menu improvements. Along with the continued success of the model’s Behind the Foil marketing campaign, which showcases how their groups put together recent meals by hand, and which they ran throughout all media channels, together with through the NFL playoffs, in addition they started selling their beef stew barbacoa, emphasizing a cooking recipe that efficiently carried out extra transactions and bills. On the identical time, in addition they introduced again Hen Al Pastor, which was some of the requested new menu gadgets, thereby making certain that its model engages its prospects with a related eating expertise together with impeccable execution. On the identical time, I additionally like that the corporate can also be utilizing its digital attain of 40 million rewards members to run focused promotions to extend buy frequency and spend whereas efficiently driving new signups.

The final technique I would like to attract your consideration to is the corporate’s tradition of bettering productiveness by investing in expertise and innovation, which incorporates their automated digital manufacturing and Autocado, which they’ll roll out to eating places within the black half of the 12 months. I imagine these applied sciences will enhance consistency, particularly in high-traffic eating places, thus paving the way in which for additional enhancements, buyer engagement and transaction quantity.

Turning to profitability, the corporate spent 28.8% of its income on meals, beverage and packaging, down 40 foundation factors from the prior 12 months. This was primarily pushed by larger menu costs from October 2023 because of larger meals inflation on gadgets similar to beef and meals. On the identical time, their labor prices additionally fell 20 foundation factors year-over-year to 24.4%, pushed by larger transaction quantity and price per buyer to unlock gross sales leverage that offset wage inflation. . In the meantime, the corporate reported GAAP working revenue of $441 million, up 20% year-over-year for a margin of 16.3%, as the corporate benefited from improved unit economics from larger transaction quantity and buy order sizes mixed with decrease transport and advertising prices.

The dangerous: Volatility in meals costs and wage inflation might squeeze margins if shopper spending slows.

Whereas the corporate raised its annual comparable restaurant gross sales progress estimates by the mid-to-high single digits, there have been some feedback from administration within the earnings report that made me involved concerning the general profitability image within the close to time period. Throughout the earnings name, administration famous that it might see value will increase for some inputs, primarily avocados, coupled with wage inflation of about 6% because of California’s minimal wage enhance. To date, the corporate has been capable of efficiently go on extra prices to shoppers within the type of larger menu costs with out hurting their backside line as shopper demand has remained resilient amid a robust labor market and steady monetary situations. Nonetheless, the state of affairs might change within the coming quarters if they’re unable to go on the prices to shoppers if meals value volatility and wage inflation proceed to stay excessive. This would be the case if we see a deterioration in general macroeconomic situations, with prospects more likely to decelerate within the frequency and dimension of their purchases at Chipotle given the weak point in labor market situations.

On the identical time, whereas the corporate is having fun with worldwide enlargement success within the Center East, Europe and Canada, with Canada main the corporate in key working metrics together with throughput, there are uncertainties associated to repeating related progress tales in all worldwide markets, which can lead to elevated advertising and different working bills whereas lowering gross margins.

Tying all of it collectively: Chipotle is overvalued at present ranges.

Trying forward, I’ll use consensus estimates of income and earnings progress over the following 3 years to provide you with a good worth for Chipotle. So, assuming earnings develop into the mid-teens over the following 3 years, which I imagine is achievable as the corporate continues to enhance its throughput by way of coaching and expertise investments mixed with buyer engagement with related model companies and progressive menus, it ought to herald $14.37 billion in income by FY27 because it expands internationally.

From a profitability perspective, taking the consensus estimate for non-GAAP EPS of $79.12 in FY27, we see it rising at a sooner price than general income progress, which I imagine might be attainable, if the corporate will enhance its unit economic system this 12 months. a time frame when there is no such thing as a important leap in meals costs and wage inflation. This might be equal to a present worth of $65.39 in earnings per share at a ten% low cost.

Utilizing the S&P 500 as a proxy, the place its corporations have grown their earnings by a median of 8% over a 10-year interval with a price-to-earnings ratio of 15-18, I imagine Chipotle ought to commerce at about 2x the a number of progress price of his revenue throughout this time interval. This might result in a PE ratio of 35, which is decrease than the present estimated ahead PE of 40, or a value goal of $2,288, which is 27% under present ranges.

As in my earlier article on Wingstop (NASDAQ: WING ), I imagine Chipotle has carried out very effectively in driving shopper demand at a time when it has needed to increase menu costs on account of inflation in an unsure macroeconomic surroundings. In essence, I imagine the corporate is positioned to drive continued progress going ahead because it focuses on delivering improved buyer expertise in-store and digitally within the US and internationally, whereas bettering throughput to extend quantity and transaction dimension. supplies wholesome and scrumptious meals ready to the very best requirements. Nonetheless, I imagine shopper spending is more likely to decline from present ranges, particularly if the labor market weakens, in addition to a probably risky surroundings for meals value and wage progress, which might harm short-term margins. In each good and dangerous scores, I imagine investor optimism is elevated at present ranges, making the inventory weak to a short-term pullback, making it a promote.

Conclusions

Though I’m impressed with the corporate’s efficiency thus far, I cannot open a place on the present stage and can wait on the sidelines for a greater entry level. Till then, I am going to price the inventory a “promote” at present ranges.