We reaffirm our long-term Neutral recommendation on Chipotle Mexican Grill Inc. ( CMG ), renowned for its large burritos, assembly line production and natural ingredients usage. Chipotle is one of the first chains of fast casual dining establishments. Previously, McDonald's Corporation ( MCD ) held a majority interest in Chipotle and finally divested it in 2006.
After reporting below-expectation results for two consecutive quarters due to higher food prices, Chipotle's third quarter results surpassed our expectations. Third quarter earnings of $1.90 per share surpassed the Zacks Consensus Estimate of $1.85, benefiting from 24.1% year-over-year growth in revenue and 11.3% rise in comparable stores sales.
The fast food chain persisted with its 'Food With Integrity' program, which primarily focuses on using organic ingredients and the increasing mix of naturally raised pork, chicken and beef. Chipotle continues to educate its customers about the program, which it recently did by organizing an event, "Cultivate Chicago" and has also rolled out a new loyalty program named "The Farm Team". The 'Food With Integrity' initiative provides a competitive edge to Chipotle over its peers.
Chipotle boasts a debt-free balance sheet and positive free cash flow to support new unit growth as well as modest share buybacks. The company has been pursuing a commendable unit expansion plan both domestically and internationally. The company plans to open 135-145 new restaurants in 2011 and 155-165 restaurants in 2012. 30% of the planned stores will be A-Model restaurants, which provide higher returns on investment. In the international market, Chipotle currently has two restaurants both in London and Canada and expects to expand in Paris by the end of 2011. The company is also eyeing new markets such as U.K, Germany and France.
The company's first Asian-themed restaurant called ShopHouse Southeast Asian Kitchen in Washington, D.C, is also operational, which we believe will be an important long-term growth driver for the company. However, the company has no plans of opening additional ShopHouse restaurants in the near term.
During the quarter, the company witnessed double-digit comps growth, mostly driven by higher traffic, coupled with a benefit of 4.6% due to menu price hike. However, for the fourth quarter, the company expects comps to slow down due to tough year-over-year comparison and marginal menu price increase of about 20 basis points. Moreover, Chipotle estimates comps to remain in the low-double-digit range in 2011 and low-single-digit range in 2012.
Additionally, Chipotle continues to experience food cost inflation. During the third quarter of 2011, restaurant operating margin declined 100 bps for the third time on a year-over-year basis due to a 250 bps spike in commodity costs. The food cost inflation in the reported quarter was driven by higher avocado, chicken, beef, cheese, and sour cream prices. For the fourth quarter of 2011, Chipotle expects food costs to be in the mid-to-high 32% range compared with 31.0% in the year-ago quarter, due to higher grain and meat pricing, partially offset by lower avocado costs that the company sources from Chile and Mexico.
For 2012, management expects commodity inflation to be higher initially, as higher corn and grain prices continues to put pressure on meat and dairy costs, but expects the same to moderate in the mid-single digit range in the later stages. Thus, increased cost structure will continue to weigh on margins. Additionally, management expects tax rate to increase from 38.4% in 2011 to 39.2% in 2012 driven by the assumed non-renewal of the Work Opportunity Tax Credit, and the R&D credit.
Agreement of Estimate Revisions
In the last 30 days, the estimates have not budged, implying that the analysts reaffirm their view on the stock.
Magnitude of Estimate Revisions
Over the last 30 days, earnings estimates also remains unchanged at $6.81 and $8.62 for fiscal 2011 and 2012, respectively.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.