Chipotle Mexican Grill Inc. (CMG, Financial) reported third-quarter results after the close on Tuesday. I wrote a short article about the company back in July, so I thought I would provide an update.
Chipotle’s revenues in the third quarter increased 9% to $1.13 billion; year to date, revenues have increased 17% to $3.37 billion. Comparable store sales in the quarter were up only 1% despite an easy comparison (comps were down 22% in Q3 2016). That is a notable slowdown from the 8% comp improvement reported last quarter (albeit against a slightly easier 24% comp decline in Q2 2016). There was a small impact to comps from Hurricanes Harvey and Irma in the United States, but it was not meaningful enough to change my overall read on the results (unimpressive).
One of my concerns last quarter was that even though the reported comp number appeared attractive (at 8%), it masked a stabilization in the two-year trend. The math showed the comps in the back half of 2017 – particularly in the fourth quarter - would look much worse if the two-year stack did not improve. As indicated above, the two-year stack actually decelerated in the third quarter. This is not an encouraging result; for now, it appears unit volumes have reset at a level well below a few years ago (before the food safety issues).
With much work left to be done, management made the decision to materially slow new unit growth: the company expects to add 130 to 150 new stores in 2018, compared to 195 to 210 in 2017. It sounds like this slowdown may bleed into 2019 as well. I do not have any particular issue with this decision in the short term, and in some ways I think it's a good idea. On the other hand, it is important to reiterate new unit growth (and the attractive unit economics Chipotle has historically reported) remains important to the investment thesis. If we are looking at slower unit growth and / or less attractive unit economics, that has an impact on intrinsic value.
I continue to be encouraged by progress in mobile ordering, which reached 8% of sales in the third quarter. Chipotle completes these orders through a second make-line that allows “normal” operations to continue unaffected. The company is set to roll out a new app with mobile payment options, a step toward removing the “pay in store” option that slows throughput on digital sales. It sounds to me like Chipotle is effectively creating an in-store "drive-thru” option that should help reduce long customer wait times and improve throughput during peak times at the company's busiest locations (by reducing congestion on the first make-line). We need to see continued progress on this front.
It also sounds like Chipotle has room to move menu prices higher (needed to cover cost inflation), with "little to no resistance" on the increase they took last year at 500 locations (roughly 20% of the base). The company plans a similar price increase (of approximately 5%) in an additional 900 locations next month and through the remainder of the store base in 2018.
Chipotle has spent $210 million on repurchases in 2017, a meaningfully slowdown from the $771 million spent through the first nine months of 2016. The pace of repurchases picked up in the third quarter to $103 million (at an average cost of $341 per share); the number of outstanding shares has declined by roughly 2.5% over the past year. The balance sheet continues to look solid, with roughly $550 million in net cash and investments on the books at quarter end.
Conclusion
It looks like the stock will take a big tumble on these results (which is not unreasonable in my opinion). My concern as a long-term investor is the results in the out years are largely dependent upon continued comp growth to drive improved unit economics. If sales per location remain a few hundred thousand dollars below where they were in 2014 & 2015, you will see a disproportionately large hit to unit profitability (deleveraging). Said differently, if Chipotle does not improve its average unit volume, the road back to historic restaurant level margins will be a difficult one.
Disclosure: Long CMG.
