On Thursday, Chipotle Mexican Grill (NYSE: CMG) reported that adjusted earnings per share reached $2.16 last quarter, up more than 60% year over year. That also surpassed the average analyst estimate by $0.16.
Nevertheless, investors weren't sure what to think about the fast-casual chain's results, as Chipotle fell slightly short of analysts' estimates for revenue and comparable-restaurant sales growth. Bears think that Chipotle's current earnings growth merely reflects easy year-over-year comparisons and will soon peter out. Yet there is growing evidence to the contrary, indicating that Chipotle could continue posting strong earnings growth for the foreseeable future.
Another step forward in the recovery
Chipotle Mexican Grill's revenue reached $1.23 billion in the third quarter, up by 8.6% year over year. More than half of this revenue growth was driven by the burrito chain's 4.4% comp sales gain, which was in turn powered by a 48.3% surge in digital sales, as mobile ordering takes off.
Higher menu prices drove further profit growth at Chipotle. Restaurant-level operating margin reached 18.7% last quarter (up from 16.1% a year earlier), primarily due to lower food costs as a percentage of revenue.
Sales and profit continued to recover at Chipotle last quarter. Image source: Chipotle Mexican Grill.
There was a lot of "noise" in Chipotle's other operating expenses, due to restructuring costs related to closing dozens of underperforming restaurants this year and relocating the corporate headquarters to California. But excluding all of those items, adjusted net income jumped 60% to $60.7 million, despite $10.6 million in costs from Chipotle's biennial manager conference. EPS grew at a slightly higher rate due to share repurchase activity.
Traffic is steadily moving in the right direction
The only negative point in Chipotle's Q3 sales performance was that comparable-restaurant traffic decreased 1.1%. The 4.4% comp sales gain was more than explained by higher menu prices and people spending extra to add queso to their orders. Chipotle can't count on raising prices every year, so without a return to traffic growth, its comp sales gains won't last.
However, traffic trends are gradually improving. Traffic was down 2.6% in the first half of 2018, including a 1.8% decline in the second quarter.
Chipotle's performance early in the fourth quarter hints at further improvements. Comp sales have increased about 4% in October, according to CFO Jack Hartung, driven by the company's latest marketing campaign. That level of growth might not seem very impressive at first. But Chipotle has now lapped the nationwide rollout of queso last September. Thus, it is delivering a similar level of comp sales growth with less of a tailwind from transaction prices. This suggests that traffic trends are set to improve again in the fourth quarter.
The food safety threat is fading
Another encouraging sign in Chipotle's third-quarter earnings report was that the chain's latest food safety miscue had little impact on its results. More than 600 people got sick after eating at a Chipotle restaurant in Powell, Ohio, in late July, due to the bacteria clostridium perfringens, which is a common cause of food poisoning when ingredients are left at unsafe temperatures.
Ever since its late-2015 E. coli outbreak, Chipotle has been negatively affected by even minor food safety lapses. Each negative headline seemed to spark a slowdown in traffic lasting for months .
Image source: Chipotle Mexican Grill.
Obviously, Chipotle should aim to have a perfect food safety record. But mistakes do happen. The sequential improvement in comparable-restaurant traffic last quarter in the face of a widely reported food safety issue is a good sign that customers have forgiven Chipotle for its previous mistakes.
Chipotle is just getting started
Finally, Chipotle achieved its latest improvement in comp sales and traffic without much benefit from the multitude of sales-driving initiatives that are in the works. New CEO Brian Niccol has implemented a rigorous process of testing and refining new programs before rolling them out broadly, in order to ensure their success. As a practical matter, that means none of his major strategies had a major effect on the third quarter. (Niccol only joined the company in March.)
However, help is on the way. Chipotle began its latest advertising campaign (which highlights its commitment to "real" ingredients) in late September. It also started piloting several new menu items and promotions in select markets last quarter. Most notably, Chipotle began testing its new loyalty program in three cities a few weeks ago.
As these and other revenue growth initiatives are perfected and rolled out across the company, Chipotle's customer traffic is likely to improve dramatically. That would provide the foundation for a sustainable turnaround.
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Adam Levine-Weinberg owns shares of Chipotle Mexican Grill. The Motley Fool owns shares of and recommends Chipotle Mexican Grill. The Motley Fool has a disclosure policy .