Chipotle's Sales Surge On Traffic Gains; High Food Costs Dent Margins


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Strong sales, buoyed by higher traffic, helped Chipotle Mexican Grill ( CMG ) post a strong set of third quarter numbers. Total revenues for the quarter rose 18.0% to $826.9 million while the operating income surged 17% to $137.1 million. Chipotle's net income jumped to $83.4 million, or $2.66 per share, up from $2.27 per share in the previous year quarter. Shares of the company were up 8% in the post market trading.

We have revised our price estimate for Chipotle to $416, following the third quarter earnings release.

Same-Store Sales Better Than Expected

Investors were surprised by the company's third same-store sales growth of 6.2%. Sales were boosted by higher traffic. The results highlight how the company's efforts to lure more customers through new menu additions and increased marketing are paying off. After a disappointing 1% rise in the same-store sales in the first quarter, the figure accelerated to 5.5% in the second quarter.

The restaurant chain added a new tofu like product called 'sofritas' to its menu. At present, approximately 25% of the restaurants serve this product but the figure should increase to 40% by the year end. Chipotle's bet on introducing an unusual vegetarian item seems to be paying off as it already accounts for 4% of the sales at the restaurants at which it is served. (( CMG Earnings Transcript )) The menu item attracts a lot of vegetarians thereby increasing the company's customer base. Moreover, the item goes well with the restaurant chain's image of serving food better and healthier than that offered by traditional fast food chains.

Store sales were also boosted by the catering services initiated by the company at the start of the year. Catering service is offered at select restaurants currently but the company will roll out the services to all the U.S. restaurants from October end. For a service that started out this year, Chipotle has done well to expand the program to all the U.S. restaurants within ten months. According to the management, catering sales are close to 1% of the sales at the restaurants at which this service is offered. With the proportion of restaurants offering catering rising we can expect the catering sales to make a positive impact on the company's earnings in the future.

After sales slowed down last year, Chipotle's management decided to raise the expenses on marketing such as billboards and radio ads. For the full year, Chipotle expects the marketing costs to account for around 1.6% of revenues, up from the previous year's figure of 1.3%.

Comparable sales, or same-store sales, is an important measure to gauge a restaurant's performance since it only includes the restaurants open for more than a year and excludes the effect of currency fluctuation.

Higher Cost Of Raw Materials Dent Margins

In the latest quarter, Chipotle's cost of food, beverage and packaging stood at 33.6% of the revenues, up 100 basis points over the previous year's figure. Chipotle has been reluctant to pass off the higher costs of food materials to customers. At the start of the year, it intended to raise the menu prices beginning from the summer but has since decided to push these price hikes to the start of next year.

Other fixed costs such as labor, occupancy and other operating expenses (as a percentage of sales) remained relatively stable. Due to higher costs of raw materials, the restaurant level operating margins declined 60 basis points to 26.8%. The margins should continue to face downward pressure in the fourth quarter as well. Once the price hikes get implemented at the start of 2014, we could see some margin relief.

Store Addition To Continue Into 2014

Chipotle stuck to its previous guidance of adding 165-180 new restaurants in 2013. In the third quarter, the company opened 37 new stores to take the year-to-date tally to 129 stores. As of September 30, 2013, Chipotle has 1,539 restaurants globally, most of which are located in the U.S. Chipotle clearly sees a strong potential to increase store count and intends to open 180-195 stores in 2014.

The company also opened the third outlet of its Chinese cuisine ShopHouse Kitchen in the third quarter with another one coming up soon in Santa Monica. The management is still in the testing phase of the restaurant; it plans to build the brand slowly. The company hasn't given a concrete number but it certainly looks like the new ShopHouse stores will constitute only a tiny fraction of the total openings in the near future.

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