Chipotle Mexican Grill: A Tasty Investment On Our Algorithmic Forecast Menu

Chipotle Mexican Grill (CMG)

Investors can be harsh sometimes, as they were when Chipotle Mexican Grill (CMG) reported that sales in restaurants opened for at least a year had surged over 13% in the first quarter. Rising commodity prices outweighed Chipotle’s best comparable restaurant sales in nearly a decade.

As a result, shares fell from over $600 to under $500 by the end of April. Food expenses have increased from 33% to 34% and can potentially rise further. Even so, earnings and revenues were up year-over-year and comparable sales guidance increased for 2014 due to greater traffic and an increased average check. Restaurant level operating margin declined because of the higher food, beverage and other operating expenses. In order to deal with food inflation, the company has stated in the earnings call that it will review its menu prices on a market-by-market basis compared to competitors and then increase prices on average somewhere in the mid-single digits. The average increase is expected to be around 6%. While price increases can potentially cause some customers to lose their appetite, they have accepted price increases in the past. This will be the first broad price increase in 3 years. So far, Chipotle has already increased prices in one-third of the chain. Chipotle’s vigorous earnings growth has earned it a premium valuation. Revenue is on track to grow more than 20% in 2014 and historically, CMG has had an exceptionally strong return on capital plus its EVA profit trend has been outstanding. The consensus opinion on Yahoo! (YHOO) Finance is 2.0, where 1.0 is a strong buy and 5.0 indicates a sell. CMG has a mean price target of $609.83 out of 24 brokers, indicating that shares can potentially rise a fair amount from the market open of $558.84 on June 5th 2014. There are validated reasons for this opinion considering the company’s very strong underlying comp momentum, debt-free balance sheet with a growing cash balance, industry leading margins and a low double-digit unit growth profile. Problems beyond the control of management add an element of risk for this fast-casual restaurant chain such as food inflation and the ongoing debate over minimum wage. Both of which affect the entire restaurant business and not just CMG alone, so consider this when making your own assessment. While Chipotle cannot control rising food expenses, the company is trying to diminish this threat by the way it implements price increases. So what does the future hold for investors in this popular restaurant chain? Well, according to the I Know First self-learning algorithm, Chipotle has a bullish signal in the 3-month and 1-year time horizon, but has a bearish signal for the 1-month time horizon. I believe that the decision to increase menu prices can potentially hurt customer traffic, and ultimately its top-line for the immediate quarter, which would be reflected in the next earnings release. However, any consumer reaction will likely be limited for the short term. This coupled with higher commodity prices has put pressure on margins. Marketing expenses will go up as well, especially in the second and third quarter for the introduction of a new advertising campaign. However, for a long-term investor, a minor dip in the short term should not cause any loss of sleep. Driven by stable traffic with a strong market position, new menu launches, media exposure, and of course, its highly efficient business that has consistently converted revenues into profits, will be enough to withstand pressure and provide value for shareholders for the mid to long-term time frame.

Sales Mix

 

Management’s attitude on pricing is to earn pricing power. What they mean by this is that if they focus on creating the restaurant experience, cooking and delivering high quality food, then they have permission to increase prices. At the mid-single digit range, CFO Jack Hurtang stated in the earnings call that Chipotle still has more room to increase prices if need be in the future judging based on market by market pricing. So menu prices are increasing, but they are not increasing flatly across the board. The company is using a strategy of encouraging consumers to select lower-cost proteins such as chicken by increasing the price gap from steak. The price gap has been historically around $0.30-$0.40, but Chipotle intends to increase this price differential to around $0.70-$0.80 more for steak. Beef prices have risen recently and this will help the company adapt…

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