Chipotle (CMG) reported comparable store sales of 4.3% and total revenue up 14.1%. The top line came in a bit below street concensus. Traffice was down -0.3% in 2Q, but management mentioned that traffic is up in July. Management also mentioned targeted price increase in prices of barbacoa and steak items as carnitas comes back to restaurants during 3Q. Chipotle also increased prices in higher cost cities. Chipotle sees very little reaction to their price increases, and they believe they have much more room to raise prices, and I agree with that.
Chipotle said they are on track to open the 190-205 stores in 2015 having opened 98 so far. Management mentioned they would be on the high side or potentially exceed the high end of new store guidance. Comp guidance is low-to-mid single digits, but the return of carnitas and the price increases point to potential upside on comps. Street consensus for revenue growth in 3Q & 4Q is 12-14%. I could see the revenue expectations bumped up to the 14-15% growth area for the remainder of the year. The price increases are going to help, and the new marketing program will increase traffic. Chipotle also mentioned a payment system which it is working on, and this could be a driver of higher traffic in the longer-term.
Margins increased across the board. Gross margins and restaurant level margins increased 70 bps and company-wide operating margins increased 180 bps. Margins were the bright spot of the report. Execution was good in 2Q. Management mentioned a problem in their new scheduling software which would otherwise have decreased labor cost by 30 bps.
Although Chipotle has been a huge success since their spinoff from McDonald's in 2006, I don't think they have marketed their story of natural and healthy food enough. Chipotle recently began a new marketing strategy, and I am hopeful this new marketing can connect to more people. Chipotle is such a differentiated restaurant company, from the non-GMO menu to their restauranteur culture, and their marketing should highlight these differences more clearly, particularly for parents, a potentially under-marketed segment.
2Q EPS was up 27%, and I see EPS growing around 17% over the coming year. The valuation of 35x FCF puts the PEG ratio at 2.0. The longer-term earnings growth assumption could be a bit higher, potentially up toward the 21% area. Although I don't see Chipotle as cheap with a PEG in the 1.7-2.0 area, I do feel the investment is attractive given untapped growth potential through higher traffic and geographical expansion.
Michael Grove, CFA