Markets
CMG

Chipotle Investors Set the Bar Too High

Chipotle Mexican Grill (NYSE: CMG) came out with another round of strong growth on Wednesday. The burrito roller said comparable sales jumped 8.3% in the third quarter, driving revenue up 14.1% to $1.6 billion, which edged out expectations of 13%. Digital sales tripled in the period, making up 48.8% of sales in the period, a sign that the company's digital and delivery strategy continues to pay off.

However, the strong top-line performance didn't trickle down to the bottom line, as the company posted adjusted earnings per share of $3.76, down from $3.82 in the year-ago quarter, though that still topped expectations of $3.40.

A Chipotle burrito bowl with a bottle of tabasco sauce on the side.

Image source: Chipotle.

Though the burrito chain saw key costs like food and labor fall in the quarter, delivery expenses jumped and caused restaurant-level operating margin, its most important profit driver, to slip from 20.8% to 19.5%. Management explained that about half of the company's digital sales, or a quarter of total revenue from all sources, came from delivery, which carries significant expenses as it must pay third-party delivery providers like DoorDash and Grubhub.

The company records the delivery fees it charges customers as revenue, but those fees don't fully cover what it pays to delivery providers. Delivery-service revenue in the quarter more than tripled to $20.1 million, while other operating costs, which contains delivery expenses, rose from 12.8% of revenue to 16.8% of revenue.

On the earnings call, CFO Jack Hartung said that the company is testing higher delivery charges after lowering its customer fee from $3 to $1 during the pandemic. That should make up for some of the lower profitability it's seen. He elaborated: "Our goal is to provide convenient access to our guests so they can enjoy Chipotle how and where they choose to. And when customers choose a premium, convenience channel that attracts higher costs, our objective is to largely cover those costs within the channel."

In other words, delivery will continue to be a headwind on margins and the bottom line, even as it boosts sales. It's also a reminder that its digital/delivery model isn't a cure-all for the Covid-related challenges the company is seeing as it's losing a number of benefits from in-store customers, including beverage sales, which carry higher margins. Additionally, comparable-sales growth has slowed to mid-single digits since mid-September as the company laps the rollout of Carne Asada last year.

Too hot to handle

Under ordinary circumstances, Chipotle shares likely would have gained on the earnings report after beating estimates on both the top and bottom lines, but the stock finished the after-hours session down 4%.

The restaurant stock has already soared this year, up 56% year to date before the release, and shares have more than tripled from their bottom during the March crash, showing that the company's recovery has surpassed investors' highest expectations during the early days of the pandemic. However, at the stock's current price tag, those high expectations are now baked into the stock for the foreseeable future.

Even based on next year's estimates of $21.30 in earnings per share, which could come down after this report, Chipotle trades at a price-to-earnings ratio of 64, a rich valuation for a restaurant chain that's already worth about $40 billion. The company believes it can at least double its number of locations and should be able to extract increased sales from Chipotlane and its digital infrastructure. But with expectations already so high, Chipotle will have to expand margins in order to continue pushing the stock higher.

It's worth remembering that before the E. coli outbreak, Chipotle's restaurant-level margins were solidly above 20%. In fact, through the first three quarters of 2015 before the outbreak, restaurant-level operating margin was 27.9% and reached 28.3% in the third quarter, which is generally the company's busiest and most profitable time of year. At the time, Chipotle's average restaurant sales were above 2.5 billion, while they're now hovering around $2.2 billion.

In other words, there's room for improvement, but it won't be easy. Investors have been pleased with the strong sales growth during the pandemic, but the real test on margins will come once the crisis ends.

10 stocks we like better than Chipotle Mexican Grill
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and Chipotle Mexican Grill wasn't one of them! That's right -- they think these 10 stocks are even better buys.

See the 10 stocks

*Stock Advisor returns as of October 20, 2020

Jeremy Bowman owns shares of Chipotle Mexican Grill. The Motley Fool owns shares of and recommends Chipotle Mexican Grill. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

In This Story

CMG

Latest Markets Videos

The Motley Fool

Founded in 1993 in Alexandria, VA., by brothers David and Tom Gardner, The Motley Fool is a multimedia financial-services company dedicated to building the world's greatest investment community. Reaching millions of people each month through its website, books, newspaper column, radio show, television appearances, and subscription newsletter services, The Motley Fool champions shareholder values and advocates tirelessly for the individual investor. The company's name was taken from Shakespeare, whose wise fools both instructed and amused, and could speak the truth to the king -- without getting their heads lopped off.

Learn More