Chipotle (CMG) recently reported results for the second quarter of fiscal 2020.
Revenues in the quarter declined by 5% to $1.37 billion, with a mid-single digit increase in the number of restaurants (ending the quarter with 2,669 locations) offsetting a 10% decline in comparable store sales (comps). While the headline comps were clearly disappointing, which reflects the significant impact of Covid-19 early in the quarter, the trend in recent months has improved: comps declined 24% in April and 7% in May and returned to growth in June (+2%). In addition, as noted on the call, comps through the first few weeks of July were up 7%.
As shown below, the pandemic ended a string of impressive quarters in which Chipotle had consistently reported two-year stacked comps well in excess of 10%. They are on track to return to 10%+ two-year stacked comps in July.
Order ahead transactions (i.e. online and mobile) continue to drive meaningful growth for Chipotle, with a tailwind in the quarter from limited in-store dining. In the second quarter, digital was up more than 200% from the year ago period and accounted for 61% of the company’s sales. That works out to roughly $830 million in digital revenues – more than three times higher than the company’s digital sales for the entirety of 2017. In addition, as noted on the call, digital continued to account for the majority of Chipotle’s sales in June and July as in-store dining ramped up again. Currently, roughly 85% of Chipotle’s offer in-store dining again.
Importantly, the company continues to see strength in the non-delivery parts of its digital business (which has more attractive economics for Chipotle). As I’ve discussed previously, the company had guided to open more than 60% of its new restaurants with a Chipotlane in 2020. Now, given the continued success they’ve seen with the concept, they have guided to more than 70% of new restaurants in 2021 having a Chipotlane. Personally, I think this is a win-win: it enables further use of second make-lines and improves throughput in busy locations, which is good for Chipotle’s economics, leading to higher average unit volumes and higher restaurant profit margins. It also makes the experience better for digital customers with pick-up at a drive-thru as opposed to parking and walking into the restaurant to grab a to-go bag.
All that said, I’m still torn on what this means for the company over the long run. On the one hand, it’s clearly valuable to have millions of customers with your app on their phone who can easily order another bowl or burrito (in addition to presenting them with personalized offers, offering a rewards program, etc.). On the other hand, I also believe that improved online ordering capabilities will just become table stakes in the restaurant industry over time, particularly among regional and national chains. For that reason, I’m still undecided how sustainable this advantage will be for Chipotle.
The 10% decline in comps led to meaningful sales deleverage in the quarter, with restaurant level margins declining 870 basis points year-over-year to 12.2%. The combination of lower revenues and margin compression led to a 90% decline in adjusted earnings to $0.40 per share.
In terms of the balance sheet, Chipotle remains well positioned, with $935 in net cash at quarter's end. The company did not repurchase any shares in the second quarter (after suspending the program in March) and noted that they “likely won’t [buyback shares] over the foreseeable future.” Considering where the stock currently trades, I think that’s an intelligent decision.
Conclusion
While the results in April and May led to a difficult quarter, I think the results in June and July are more representative of what investors should expect in the coming years. Between operational improvements like digital that have the potential to improve throughput and the long-term economics of the business, as well as menu innovations like queso and cauliflower rice that can reengage lapsed customers and create higher average checks, the company is moving in the right direction. And while the pandemic could continue to impact the business in the short-term, the company has shown that they are in a better position than many of their restaurant peers to weather the storm.
The problem for me continues to be the valuation. At $1,140 per share, the stock trades at roughly 80 trailing earnings (and a higher multiple on 2020 earnings). Admittedly, earnings growth could be significant in the coming years as outsized same store sales growth will result in meaningful operating leverage. Management continues to believe restaurant level margins should be around 25% at average unit volumes (AUV’s) of $2.5 million - around the peak achieved prior to the company's food safety issues in 2015.
Of course, at 80 times earnings, much of that is priced in. My estimate of earnings five years out is at $40 per share to $45 per share. Said differently, on the high end of the range, the stock is trading at 25 times earnings in 2025 – and that assumes things go quite well for the company over that period. Mr. Market remains overly optimistic on Chipotle.
Disclosure: None
Read more here:
- Microsoft: Another Impressive Year - And More to Come
- An Update on Charles Schwab
- Berkshire Hathaway Meeting: 1998 Afternoon Session
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
