Restaurant chain Chipotle Mexican Grill (NYSE:CMG) released Q4 results last Thursday that, at first glance, certainly appeared caliente. However, upon closer examination there are some things that concern me and could cause investors grief in 2008.
First Impressions of the First Quarter
In the period ended December 31, Chipotle earned $17.5 million (53 cents per share) which was a marked improvement over the $10.8 million (33 cents per share) it earned in the comparable period last year.
The bad news was that the results were about a penny shy of analyst forecasts. Not surprisingly the stock got hit. In Friday's trading it opened about 10 points lower but did recover to close down about three points on the day.
However, it wasn't the EPS number or even the stock price action that concerned me.
Comps Ready To Down shift
Chipotle's Q4 same store sales increased 10.6%, and for the full year it booked an almost unbelievable 10.8% improvement in comps. That's a big achievement! Unfortunately, right near the bottom of the press release, management said it expects 2008 comps to down shift big time and be "in the low- to mid-single-digit range".
For a chain that's been experiencing double-digit year-over-year comp growth, I think its a big disappointment. I suspect the analyst community may be scaling back '08 estimates and price targets because of the reduction. This will hurt the stock. Over the last few days the average estimate from analysts surveyed by Thomson Financial for 2008 has already declined to $2.68 a share from $2.74 a share, indicating that some analysts have already decreased their numbers.
If Chipotle does start to generate comps in the low- to mid-single-digit range this is going to look pretty weak, and the stock will likely start to be valued like the rest of its fast food and casual dining brethren.
• McDonald's (NYSE:MCD) trades at 17.4-times the current year estimate of $3.18 per share, mid-single-digit comps.
• Burger King (NYSE:BKC) trades at 19.2-times current year estimates of $1.31 per share, mid-single-digit comps
• Panera Bread (Nasdaq:PNRA) trades at 19.1-times the current year estimate of $2.01, low-single-digit comps.
• Cheesecake Factory (Nasdaq:CAKE) trades at 17.9-times '08 estimates of $1.15 per share, break-even(ish) comps of -0.4%.
Very simply, what do you think might happen if Chipotle, which trades at about 39.3-times the current year estimate of $2.68 suddenly gets lumped in with those guys because of the down shift in comps? Frankly, I think it will lead to the stock taking a big haircut. (For added insight, check out How To Evaluate The Quality Of EPS.)
Ramping Up Growth or Ramping Up Trouble?
While I like to see companies that consistently grow their store footprint, I think there are times when companies should scale back new store openings, particularly when the economy is weak like it is now. However, Chipotle doesn't seem to share my view. It plans to open 130-140 new locations in 2008, which is north of the 125 it opened in 2007. That's the opposite of what some other specialty-chains are doing. For example:
• Cheesecake Factory, opened 21 stores in fiscal 2007 and plans to open between seven to nine in 2008.
• Panera Bread opened a total of 169 bakery-cafés in 2007 (which includes both Company-owned and franchised owned operations). In 2008 it plans to open 40 company and about 60 franchise locations.
I think the growth Chipotle is shooting for is too aggressive for this environment and is likely to lead to problems. Also, its important to note that up until now Chipotle has been experiencing very strong margins. Its total restaurant level operating margin increased around 180-basis points to 22.1% in 2007 from 20.3% in 2006.
Such rapid growth could put a damper on those numbers particularly in this operating environment. Opening all of these stores is going to cost plenty of money, on top of rising costs from the jump in milk, beef, chicken and other food prices. (For more on the downside to aggressive growth plans, see Is Growth Always A Good Thing?)
Bottom Line
Chipotle turned in a solid quarter, but slowing same-store-sales growth could cause analysts to change their valuations. The company has a big growth plan for the new year, but this could backfire in a slowing economy and also cripple margins. Chipotle's seemingly strong quarter is another case where it pays to read the fine print.