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Growth momentum favorite Chipotle Mexican Grill breaks down--and will need a couple of quarters (at best) to reset expectations
07/26/2012 4:05 pm EST
The stock, which closed at $403.86 a share on July 19, closed on July 25, at $296.48. That’s a loss of $107.38 a share or 26.6% in four trading days.
On the earnings line, there was nothing wrong with this earnings report. Earnings climbed 61.2% from the same quarter in 2011, beating the consensus estimate of $2.30 a share by 26 cents. That should have been enough even for a stock trading at almost 45 times projected 2012 earnings per share.
But with that kind of multiple, "nothing wrong" in the earnings line doesn’t cut it. Especially when there’s a lot wrong in other lines on the income statement.
Revenue climbed just 20.9% year-to-year and at $690.9 million for the quarter came in below the consensus Wall Street estimate of $706.92 million. Comparable store sales were 8%. That’s a level that many quick service restaurant companies would kill for, but at Chipotle it was a big drop from 12.7% in the first quarter of 2012, 10.2% in 2011, and the company’s own forecast of 11.5% for the quarter.
Even looking at these numbers and the stock’s multiple, the almost 27% drop seems extreme—until you notice how the quarter’s disappointing results took dead aim at the Chipotle’s big strengths as a company.
First, the company’s margins at the restaurant level for the quarter were extraordinarily high at 29.3%. For comparison, margins at company-operated restaurants at McDonald’s in the just completed second quarter were only 18.2%. (Operating margins for company operations as a whole at McDonald’s were 31.2%.) Margins at Chipotle climbed 3.4 percentage points in the quarter. Part of that amazing increase in margins was the result of a huge decrease in general and administrative costs to 6.1% of revenue, a drop of 1.2 percentage points from the second quarter of 2011.
Investors concluded, rightly I think, that this kind of increase in margins just wasn’t repeatable going forward. Especially once they heard the company say, in its conference call, that it had taken the bulk of price increases that it felt it could take in 2011and that the company expected rising costs in the second half of 2012 for things such as meat.
Second, the company pointed to a major deceleration in traffic growth rates as the reason for the revenue miss. This isn’t a short-term problem—traffic growth rates have moderated over the last year. The company said this deceleration in traffic growth was an effect of the slowdown in the economy. As a result, the company said, it expects same store sales growth in the middle single digits for 2012 as a whole. Considering that comparable store sales growth for the first half of the year comes to about 22%, that company forecast suggests that comparable store sales could well drop off a cliff.
One way to counter that, many analysts noted after the company’s earnings report would be an increase on spending on advertising, marketing, and promotion. That would, of course, cut into company margins.
In my post http://jubakpicks.com/2012/07/24/are-some-companies-simply-better-at-the-lots-of-work-but-no-jobs-economy/ I listed Chipotle Mexican Grill as one company that might be better suited than most to the “plenty of work but no jobs” economy. And you could hear evidence of that in the company’s conference call. Restaurant teams increased their throughput by six transactions an hour during peak hours to the highest level ever at the company. That is indeed a tribute to the company’s workers and managers and to the systems that the company uses in its restaurants. This is indeed the kind of company that you want to own in an economy like this.
It’s my experience, though, that you don’t want to buy an earnings momentum darling when the momentum has broken—especially when the company is signaling problems at maintaining growth in the second half of 2012.
I’d wait for that growth turbulence to pass and for the multiple on Chipotle to stabilize at something closer to the 24% to 25% earnings growth rate that the company will achieve for 2012 and 2013, according to Wall Street estimates.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did not own shares of Chipotle Mexican Grill as of the end of March. It did own shares of McDonald’s as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/ .
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