Chipotle Mexican Grill Inc. (CMG, Financial) went public in January 2006. Over the next decade, the company was firing on all cylinders: from 2005 to 2015, Chipotle reported average comp store sales growth in the high single digits. Average unit volumes (AUV) increased from $1.4 million to $2.4 million. The combination of attractive AUV growth and a four times increase in the store count (from 481 to 2,010) resulted in a decade of 20%-plus annualized revenue growth (from $630 million in 2005 to $4.5 billion in 2015).
With higher AUVs and a growing store base came operating efficiencies; corporate EBIT margins roughly doubled, with diluted EPS increasing more than 10 times in the decade to 2015. Even with limited financial leverage, return on equity was around 25%. In August 2015, the high watermark for Chipotle, the stock traded at $750 – a price-earnings (P/E) multiple of 50 times (on 2015 EPS of approximately $15 per share).
And then the bottom fell out.
After the company’s widely publicized food safety issues in October and November of 2015, customers fled. The business results reached their nadir in the first quarter of 2016, when comps fell 30%. Despite spending significant amounts of money on promotions and advertising to try and entice customers to return to its restaurants, full-year comps still declined 20% in 2016. As AUVs fell, the company could not reduce expenses as quickly. The result was a black eye for the income statement: diluted EPS fell by 95% in 2016.
I think it is safe to say 2016 was all about crisis management (stop the bleeding). With the damage largely behind it, 2017 has been about getting the train moving in the right direction again. Personally, I think the Chipotle story is compelling. The unit economics are attractive, the balance sheet gives it some flexibility and there’s room for continued unit growth (even if you assume none of its other concepts will work). In addition, the board has incentivized management with highly challenging LTI plan targets that may suggest some internal optimism on how this might play out over the next few years (three-year performance period).
Those positive attributes are offset by recent results. The most notable example in my mind is the 8.1% increase in comps Chipotle just reported in the second quarter. While that sounds like a pretty good number on the surface, this result is lapping a -23.6% comp in the year-ago period.
The cumulative result since 2015 (the two-year stack) has been a 17% decline in same-store sales. Importantly, that result was practically dead-on with the first-quarter result. To me, this suggests the recovery may be losing some steam. The stores may have permanently reset at an AUV base well below where they were back in 2015. If that is accurate, and the current trend holds, comps in the fourth quarter (when the comparison gets a lot tougher) will be down 10% or so.
This concern was exacerbated by this comment on the conference call:
“We concluded that we need new news... To win new customers, attract lapsed customers and increase the frequency of our existing customers, we need to evolve the Chipotle experience and create more compelling reasons for customers to visit.”
Some customers that left because of the food safety issues have not returned – and they do not intend to do so unless Chipotle gives them a good reason (apparently all the promotions they have offered over the past year and a half do not qualify as a good enough reason).
The primary reason these lapsed customers have not returned is “boredom,” according to internal research. It sounds like these customers think the menu is stale. Management thinks adding queso and dessert may be the answer they are looking for. Time will tell.
Conclusion
From $750 in August 2015, Chipotle stock is now down more than 50% (to $340 per share).
The model I have built for Chipotle suggests a price in the low to mid-$300s per share makes sense with some pretty reasonable assumptions (at least, they are reasonable to me).
While I am tempted to buy some Chipotle shares, I have not (yet). Even if I did, it would be a relatively small position (to account for the fact it is unlikely I would ever make the stock a large holding in my portfolio). If the market is kind enough to keep pushing the stock lower, it will make my decision easier (fingers crossed). For now, I think I will stay on the sidelines.
Disclosure: None.
