On Wednesday, Chipotle Mexican Grill Inc. (CMG, Financial) reported results for the third quarter of fiscal 2020. The company returned to growth in the third quarter, with revenues up 14% to $1.6 billion. Growth in the quarter was driven by a combination of higher same-store sales (up 8%) as well as a mid-single-digit increase in the company's footprint (up 6% year over year to 2,710 locations).
As shown below, after a difficult point in the second quarter as the company navigated through the heart of the pandemic, Chipotle has returned to two-year stacked comps well into the double digits.
Order-ahead transactions (online and mobile) drove meaningful growth for Chipotle: in the quarter, digital was up more than 200% and accounted for roughly half of the company's sales. Importantly, the company continues to see strength in the non-delivery parts of its business as well, which accounts for roughly half of Chipotle's digital sales and has more attractive economics for the chain. As a result, the company is increasingly focused on locations with Chipotlanes (digital drive-thrus): of the 41 net new locations opened in the third quarter, 26 had Chipotlanes. This pace is set to continue, with management guiding to more than 70% of new locations in 2021 to have a drive-thru.
As I've discussed in the past, this is a major development for the company: it enables further use of second make-lines and improves throughput in busy locations, which is good for Chipotle's economics (higher average unit volumes and restaurant margins), but it also makes the experience better for digital customers (drive-thru as opposed to parking and walking into the restaurant).
The question is how Chipotle balances the incremental revenues available through the digital business with the costs associated with serving these customers (most notably delivery). This was evident in the third quarter: despite the 14% increase in revenue, restaurant level margins contracted 130 basis points to 19.5%. This was primarily due to outsized other operating costs (up 400 basis points year over year to 16.8% of sales), the line item that captures delivery fees. Management is testing delivery menu price increases to try and address this issue; time will tell if that adjustment has an impact on customer behavior (delivery order volumes).
The contraction in operating margins in the quarter more than offset the double-digit increase in revenue, with adjusted earnings per share falling 2% year over year to $3.76 per share.
Chipotle remains well positioned from a financial perspective, with $1.1 billion in net cash at quarter's end. The company suspended its share repurchases in March and did not buyback any shares in the third quarter. Based on the commentary on the conference call, it does not sound like that will change in the near future ("we'll return excess cash to shareholders when the environment is more stable and more predictable"). Considering where the stock currently trades, I continue to believe that's an intelligent decision.
Conclusion
The strong rebound in Chipotle's financial results in the third quarter is another encouraging sign for investors. Continued success in the digital business has the potential to improve the long-term economics of the business, with the company leaning into the opportunity with Chipotlanes. This period has clearly shown that Chipotle is in a better position than many of its restaurant peers to weather periodic storms like the one in 2020.
As is often the case when a business is hitting its stride, the investment decision comes down to valuation. At $1,340 per share, the stock trades at more than 90 times trailing earnings (and a higher multiple on 2020 earnings). Looking forward, my estimate of earnings five years out is roughly $50 per share. Said differently, the stock is trading at more than 25 times earnings in 2025 – and that assumes things continue to go well for the company over that period (as we've seen in the past five years, that is far from a certainty).
While I appreciate the growth story, with management reiterating their belief that the chain can more than double its unit count in the U.S. over the long run, I continue to believe Mr. Market remains overly optimistic on Chipotle (or at least appropriately considers this potential). I would love to own this company (again) at the right price – but the "right price," for me, is well below today's levels.
Disclosure: None.
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