Chipotle Mexican Grill: Q2 Earnings To Come In Ahead Of Expectations

Investment Conclusion

Chipotle Mexican Grill (NYSE:CMG) is scheduled to report F2Q2022 Earnings on July 26, 2022, following market close. The average consensus revenue and earnings per share estimates for the quarter are ~$2.25 billion and $9.08. We expect the company to beat analyst top-line and bottom-line projections for the period.

Specifically, we anticipate, substantial revenue growth driven by: the continued uptrend in dine-in sales, sustained off-premise transactions, significant growth in the number of stores and Chipotlanes over FY2021 and the first quarter (51 stores, including 42 Chipotlanes were opened), the price increase implemented towards the end of the first quarter, and improved throughput due to higher staffing levels. In addition, despite commodity inflation related to beef, dairy, avocados, and tortillas, we anticipate sequential margin expansion due to revenue leverage from the considerable growth in sales, increased labor efficiency (as wage growth appears to be stabilizing), and the hike in menu prices. As a flow-through, we expect significant year-over-year boosts in earnings and free cash flows, for the second quarter. For F2Q2022, management has guided to year-over-year same-store sales growth of between ~10% to~12%, and normalized restaurant margins of ~25%.

Over the back-end of the year, although, we expect recessionary trends to gather momentum, based on the solid value proposition CMG offers customers, and the recent and ongoing footprint expansion, we don’t anticipate major deceleration in CMG sales growth. In addition, the company might launch a new menu item, garlic guajillo steak, which is currently being piloted at 102 stores, during the fourth quarter (in our estimate) which will encourage additional customer demand. Moreover, considering our thesis that the decline in commodity prices currently unfolding is likely to persist over the back-half, we anticipate gains in gross profits. In addition, lower marginal costs associated with fixed expenses due to sharply higher sales, at the restaurant level, and additional leverage at the operating expense level, will further expand margins, in our opinion. Overall, based on surging sales and margins, we expect exceptional growth in earnings and free cash flows, for FY2022.

CMG has indicated plans to open between 235 to 250 new locations during the year, ~80% of which will feature Chipotlanes. Despite, the construction delays being encountered across the U.S., we expect the company to achieve its new unit development target for FY2022, based on our conviction that management is likely highly interested in rapidly monetizing the strong customer demand for their product across the country. In addition, recall that Chipotlanes are highly valuable as they are associated with ~15% higher sales than non-Chipotlane stores and support only digital transactions, which generate the highest margins, and customers that place orders using digital media, transact more frequently and with higher check values. Therefore, as the number of Chipotlanes as a percent of the store base advances, average unit volumes will expand accordingly.

Longer-term, CMG’s planned growth in footprint to 7,000 restaurants within ~10 years, from the current ~3,000 will drive the majority of its growth. Given that the massive expansion in the number of restaurants is likely to be focused on under penetrated regions, we do not expect cannibalization in sales or declines in average unit volumes, as new units are established. Additional growth will be derived from an increase in same-store sales attributed to: Chipotlanes, menu innovation, the loyalty program, some conversion of dine-in orders to digital, and the continued growth of off-premise sales. Given the potential significant expansion in sales, margins are likely to increase as marginal fixed costs decrease substantially and economies of scale related to advertising and the digital platform are secured. As a flow-through of higher sales and improved margins, we expect substantial growth in earnings and free cash flows over an elongated time horizon.

Considering the above discussed factors, we are confident that the firm will handily meet and exceed our our normalized 10-year revenue growth rate of 17%, which incorporates a 10-year store count of 7,000 and average unit volumes of over 3 million. Therefore, we are maintaining our 1-year Price Target of $2,020/share for CMG. Reiterate Buy Rating.

(Please go through our initiation report “Chipotle Mexican Grill: Turnaround Story With Substantial Growth Potential” and related notes for our long term opinion on the stock).

Key Takeaways From The First Quarter

F1Q2022 Results Summary. For the quarter, CMG reported revenues of ~$2.02 billion (+16% compared to F1Q2021) beating analyst expectations of ~$2.01 billion, and earnings per share of $5.59 (+25.6% on a year over year basis) was below consensus estimates of $5.64. Excluding extraordinary items, earnings per share would have been $5.70, representing an increase of 6.3% from F1Q2021. In addition, compared to the same quarter last year, same-store sales increased by 9% over the first quarter. Net income for the period was ~$158 million reflecting an expansion of 24.5% on a year-over-year basis. Restaurant margins of 20.7% decreased by 160 bps compared to the prior year’s same quarter.

Digital Sales Continued To Deliver. Despite, ~33% growth in dine-in transactions, digital sales accounted for ~40% of total sales, inline with trends evidenced over recent quarters. Sales in the category were supported by delivery orders which represented ~20% of total sales, sales related to the loyalty program which necessitates online ordering and payment and which is now comprised of ~28 million members, and Chipotlane transactions which require mobile order and payment.

We expect digital sales to be sustained even as walk-in sales continue to accelerate. In particular, we expect the rewards program enrollment to advance at an accelerated pace, reflecting in improvement in the volume of online orders. In addition, the massive growth in the number of Chipotlanes, will drive substantial upside in digital sales. Given business dynamics associated with online transactions, we are encouraged by the its growth potential.

Throughput Growth Represents An Opportunity. Considering that restaurants that emphasize customer experience typically generate excellent guest satisfaction scores which reflect in higher sales, we are encouraged by CMG’s focus on increasing throughput. The element suffered during the pandemic due to staffing shortages, and remains below peak levels. Specifically, currently throughput is at 25 entrees/team member inline with the pre-COVID performance but below the best low 30’s/team member on the front make-line. It is noteworthy, that performance is measured by entrees/team member on the front make-line and by promised time execution on the digital make-line.

As staffing levels have increased significantly, the objective is to rapidly recover throughput by training employees. With a view to incentivize make-line goals, crew members and managers have been promised performance and accountability bonuses. In addition, a scheduling tool is being rolled out to ensure that the right team members are placed at the right place at the right time during shifts. Based on the initiatives, throughput increases have been recorded on the front make-lines and digital make-lines.

We expect a favorable impact on sales as performance on the make-lines improves as anecdotal evidence suggests that guests walk away from queues if the service on the front make-lines is not swift, which is often the case at CMG’s high traffic restaurants during peak dining hours.

Remained Focused On Employee Development. Considering that front-line staff are pivotal to efficiently execute restaurant operations and generate customer satisfaction, CMG has appreciated their efforts since the company’s founding by always providing highly competitive wages and benefits. CMG has evolved its employee retention program through training and development that provides staff with the opportunity to advance from a front-line role to that of a General Manager earning ~$100,000/year within 3.5 years. In addition, CMG involves team members in decisions regarding restaurant operations, including recently in the determination of activities that would be best suited for automation.

We believe that the company is on the right path in regards to employee hiring and retention practices, particularly given that with 10- year annual footprint growth plans of between ~8% to ~10%, CMG is in the market for a large number of front-line staff, restaurant managers, and General Managers, over an elongated time period. Word-of-mouth plays a key role within the restaurant industry, and respecting employee labor and time, will possibly reflect in below industry average staffing challenges, in our judgment.

Automation On Cards Over The Near-Term. In order to optimize employee labor and time requirements, CMG is introducing substantial automation in its stores. It has already rolled out a new labor scheduling program and has begun testing radio frequency identification technology to enhance traceability and inventory systems. In addition, a pilot is also being run on an autonomous kitchen assistant called Chippy that will prepare tortillas chips. The robot is expected to be situated in a Southern California restaurant, once it passes the stage-gate process, and after securing feedback from team members and guests.

In a further push towards innovation, CMG recently created a venture fund to invest in early stage companies that are strategically inclined with its objective of enhancing employee and guest experience and advancing CMG’s food with integrity mission, through digitization and automation.

We believe that given technology’s ability to substantially improve restaurant operations, CMG’s efforts in further embracing digital tools and automation are prudent. In addition, considering that ultimately the endeavor is likely to reflect favorably on the bottom line, we couldn’t be more supportive.

Balance Sheet Remains Solid. At the end of F1Q2022, the company had a cash and cash equivalents balance of ~$1.2 billion and no long-term debt on its balance sheet. CMG can borrow an additional $500 million to fund operations under a credit facility, it has available. During the period, the firm bought back ~$260 million worth of shares at an average price of $1,490. Given its funding position, we believe that CMG will handily maintain sufficient capital to fund operations and execute on the new unit development program.

Bottom Line

CMG is constantly crossing all its T’s and dotting all its I’s – food prepared from scratch in its restaurants using fresh ingredients including humanely grown beef and chicken, great value proposition for customers given the large portion sizes and reasonable menu prices, well paid front-line employees with options to develop long-term high paying careers at the firm, deployment of the outsized free cash flows to optimize operations through automation among others, accelerated footprint expansion to rapidly monetize customer demand, and the most important operating restaurants with excellent unit economics, translating to significantly higher earnings every year, and ever increasing returns on capital for investors.

CMG has always been head and shoulder above the rest, except when it was faced with the food contamination issue. That’s behind them, and they capitalized on the pandemic, and are dealing well with inflationary pressures. There does not appear much on the horizon that could derail the company from developing into a substantially larger highly profitable organization, once it achieves 7,000 stores, which we believe, is a placeholder, with an ultimate footprint which is likely to be much larger.

Therefore, we view the ridiculous pullback in CMG’s stock as an excellent opportunity to accumulate shares at prices far below their intrinsic value. Buy, Buy, Buy.