Stock Forecast: Chipotle (CMG) Stock Surges After Beating Earnings and Announcing Stock Buyback

 

This article was written by Esther Hanon, a Financial Analyst at I Know First.

 

[Source: REUTERS/Carlos Barria/File Photo, May 1, 2018]

Stock Forecast: Chipotle (CMG) Stock Surges After Beating Earnings and Announcing Stock Buyback:

“Job number one is to remind people why they love Chipotle. I think there [are] opportunities to use what we have and present it in new forms, new varieties, to get people re-engaged with what they love about Chipotle. There is an opportunity to bring in new flavors as well. One thing that’s great is we got carnitas and chicken that people absolutely crave.”

— CEO Brian Niccol

Summary:

  • Shares of Chipotle Mexican Grill, Inc. have been on a post-earnings tear. While customer traffic trends have been weak ever since Chipotle’s late-2015 E. coli outbreak, the company’s profit margin came in well ahead of the company’s plan for last quarter.
  • Chipotle reported earnings on Wednesday April 25, which sent the stock into orbit. Earnings blew past expectations, coming in at $2.13 per shares compared to consensus of $1.60 per share. Revenues were $1.15 billion, which were only in-line with analyst expectations.
  • Chipotle stock has added some 87 points, or 25%, since reporting earnings. While a move higher was undoubtedly warranted, the massive move higher has reached an extreme — both on a fundamental and technical basis.
  • Chipotle Mexican Grill Inc. and DoorDash have partnered to make delivery service available at its more than 1,500 restaurants nationwide.
  • Chipotle is up nearly 48% for the year so far while the S&P 500 index is down 0.1% for the period.
  • CMG is increasing its buyback program by another $100 million. As of March 31, Chipotle had about $50.2 million available for repurchases from its previous buyback program, which had about $118 million at the end of last year.

Wednesday, April 26th was a great day to be a Chipotle Mexican Grill, Inc shareholder. Following the release of the company’s first-quarter earnings after market close the day before, one of last week’s biggest winners was Chipotle, soaring roughly 28.7% after posting better-than-expected financial results. The burrito roller is still in the early stages of a turnaround, but the market clearly likes the direction the chain is taking since obtaining Taco Bell’s CEO as its own. Chipotle stock has now soared 70% since announcing that Brian Niccol would be its new CEO two months ago. Revenue rose 7.4% to hit $1.148 billion in Chipotle’s first quarter, with expansion and a 2.2% uptick in comps combining for the top-line lift. This is the chain’s third straight quarter of single-digit revenue growth, but this time it’s pitted against a 28.1% surge — its strongest quarter since the summer of 2014 — a year earlier. Margins widened, and earnings per share rose by a better-than-expected 33% to clock in at $2.13. 

[Source: Yahoo Finance, January- April, 2018]

No More Heartburn for Chipotle:

Chipotle achieved a 7.4% revenue increase in the first quarter on 2.2% comparable-restaurant sales growth. (The comparable sales gain would have been 2.7%, excluding the impact of deferred revenue related to Chipotle’s limited-time Chiptopia loyalty program). This comfortably beat the company’s forecast for a 1%-2% comp-sales increase, excluding Chiptopia. Still, Chipotle relied on higher prices and the addition of queso to its menu to drive its comp-sales growth. Customer traffic continued to decline, falling by more than 3%. Customer traffic still is falling at Chipotle. Meanwhile, Chipotle’s restaurant-level operating margin rose to 19.5% from 17.7% a year earlier, mainly due to lower food and marketing costs as a percentage of revenue. By contrast, management had projected that the restaurant-level operating margin would only be 16% to 16.5% last quarter. The result was a massive earnings beat. Earnings per share (EPS) came in at $2.13, up 33% year over year and far above the average analyst estimate of $1.57. Furthermore, Chipotle achieved this strong EPS performance even though its effective tax rate for the quarter was 36.9% — well ahead of the normalized 28.8% effective tax rate that Chipotle expects to pay going forward.

Did the company deliver? In short, yes and no. Sales were up 7.4%, same-store sales (also called comps) increased 2.2%, and earnings per share jumped 33%. But even as profits and sales improved, Chipotle continues to struggle to bring back customers: Comps growth was entirely due to a 4.9% average price increase, and fewer customers ate at Chipotle than in the year-ago quarter.

The numbers: Weak traffic still a concern, but some positive trends

Here’s a closer look at some key metrics for Chipotle’s first quarter:

Metric Q1 2017 Q1 2016 Year-Over-Year Change
Revenue  $1,148.4  $1,068.8 7.4%
Net income  $59.4  $46.1 28.9%
Earnings per share  $2.13  $1.60 33.1%
Comparable sales 2.2% 17% n/a
Restaurant-level operating margin 19.5% 17.7% 10.2%
Labor percent of sales 27.8% 26.9% (3.3%)
Food/packaging percent of sales 32.4% 33.8% 4.1%
Occupancy/other operating costs percent of sales 30.1% 31.5% 4.4%

Data Source: CHIPOTLE, Revenues and Net Income in Millions

Labor costs increased from 26.9% of sales last year to 27.8% in the quarter, largely based on higher wages, up about 5% on average. A decrease in food and paper goods costs, timing of some other operating costs, and an average 4.9% price increase more than offset higher labor costs. The end result was Chipotle’s restaurant-level operating margins increasing sharply to 19.5%, one of its best quarterly results in the past several years.

Furthermore, the comp result may have been a little bit better than advertised. The “underlying” comp result was actually 2.7%, with a 50 basis point impact from redemptions related to last year’s “Chiptopia” promotion. While one could argue that those redemptions were customers who wouldn’t have come in without their free burrito coupon, the fact that they did come in is still a positive sign for Chipotle’s brand health. The company also continues to get incremental sales from queso; on the earnings call, CFO Jack Hartung said the average check was boosted about 200 basis points by queso orders. Any way you slice it, Chipotle’s comp result was an improvement from the two prior quarters, where it didn’t manage to get past 1% growth.

The next step? Increasing customer traffic. With a 4.9% price increase and 2.2% comp growth, Chipotle once again served fewer customers than in the year-ago quarter.

There are lots of additional opportunities

Some pundits opined that Chipotle’s strong Q1 performance was a sign that new CEO Brian Niccol hit the ground running. However, given that he started just a few weeks before the quarter ended — and newly appointed chief marketing officer Chris Brandt joined the company on April 2 — it seems unlikely that management changes had much impact on Chipotle’s first-quarter results. That’s good news for investors, as it means that the payoff from any changes made by the new management team would represent pure upside relative to Chipotle’s recent trajectory. Indeed, Niccol sees a number of ways to improve near-term performance.

Most significantly, he highlighted opportunities to make Chipotle’s marketing more effective. Niccol believes that Chipotle should be able to make its brand much more visible, even with its current marketing budget. That could, in turn, boost customer traffic trends. Niccol also noted that Chipotle needs to do a better job of drawing attention to its new mobile order and delivery capabilities. Lastly, Chipotle is likely to close some of its cash-flow-negative restaurants this year, which will naturally improve profitability going forward.

There’s even more room for Chipotle to improve its sales and earnings trajectory beyond 2018. Niccol noted that he’s a big believer in innovation. Menu changes, expanded operating hours, and even drive-thru windows could come to Chipotle in the future. However, changes like these will need to be developed and tested before they can be rolled out broadly.

The sky’s the limit

Chipotle stock surged 24% on Thursday, the day after the earnings report, closing at $422.50, more than 70% above the multiyear low it reached in February. That means the stock is trading for a lofty 68 times Chipotle’s 2017 EPS of $6.17. However, while that earnings multiple may seem excessive based on the high single-digit growth rate of Chipotle’s restaurant base, it’s quite reasonable based on the company’s margin-expansion potential. Chipotle’s 2017 operating margin was just 6%, down from 17.6% in 2014. If management’s efforts to reinvigorate store traffic succeed, Chipotle should be able to more than double its operating margin over the next several years, even if the previous high-water mark is out of reach. Based on a low- to mid-teens operating margin and a relatively steady pace of store openings, EPS could reach $30 to $40 or even more within five years. That leaves plenty of potential upside for Chipotle stock.

Chipotle is increasing its buyback program by another $100 million, the food chain said. As of March 31, Chipotle had about $50.2 million available for repurchases from its previous buyback program, which had about $118 million at the end of last year. Chipotle shares were up 22% in Thursday’s session after it reported better-than-expected first-quarter sales and earnings and as its new CEO hinted at fresh menu items to come. Revenue increased 7.4% year over year to $1.15 billion as net income increased to $59.4 million, up from $46.1 million a year prior. That performance was driven in part by increased prices, which rose 5% to 7% in January.

Toward a Turnaround

The Denver-based burrito maker’s shares have been struggling in recent years, down 46% in the past three years after a series of food safety scares starting with an E. coli outbreak in 2015. But the stock is up more than 40% year-to-date as it works toward a turnaround with former Taco Bell CEO Brian Niccol at the helm since March 5. At Taco Bell, Niccol launched mobile order and pay and added new menu items that proved successful, and he is taking steps toward the same strategy at Chipotle. In an investors call, he also said Chipotle has developed some light-hearted ads to revive the brand by underscoring “real ingredients” and is expanding its delivery service. Chipotle expects same-store sales to increased in the low-single digits this year as it opens 130 to 150 new locations.

[Source: TradingView]

Partnership with DoorDash:

Customers that order $10 or more of food from CMG via DoorDash can get free Chipotle delivery. This offer is available at all participating locations. This offer will be up for grabs starting today, Monday, April 30, 2018, and will last until Sunday, May 6, 2018. The company notes that this will allow for free Chitpole delivery on Cinco de Mayo, which will be taking place on May 5, 2018. The offer for free Chipotle delivery also requires customers to use a special coupon code at checkout. This code is “GETCHIPOTLE”. The code can be applied to orders made through DorrDash’s website or mobile app.

“Delivery is an important way we are making Chipotle even more convenient and accessible to our customers who want to get Chipotle delivered right to their home, office, or wherever they are,” Curt Garner, Chief Digital and Information Officer at Chipotle, said in a statement. “By partnering with a delivery leader like DoorDash, we are making it even easier for customers to enjoy all the real ingredients that make up our delicious food. According to Chipotle, the new deal with DoorDash allows it to now deliver Mexican food to customers from 1,500 locations across the U.S. The company notes that this is the largest delivery footprint it has ever had.

Company Comments:

Brian Niccol, chief executive officer had this to say to investors:

“Chipotle is a purpose driven brand with loyal customers, passionate employees, industry-leading economic potential, along with incredible brand equity, and craveable food with integrity, all built over the last 25 years. While the company made notable progress during the quarter, I firmly believe we can accelerate that progress in the future.  We are in the process of forming a path to greater performance in sales, transactions, margins and new restaurants. This path to performance will be grounded in a strategy of executing the fundamentals while introducing consumer-meaningful innovation across the business. It will also require a structure and organization built for creativity, action and accountability.  Finally, Chipotle will have a culture that is centered on running great restaurants, putting the customer first, innovating for today and tomorrow, supporting each other, and delivering on commitments. The future will be meaningful at Chipotle.”

Analyst Recommendations:

According to analysts at Yahoo Finance, 3  analysts recommended a “Strong Buy” rating, 5 a “Buy”, 22 a “Hold”, and 3 “Underperform”.

[Source: Yahoo Finance, May 1st, 2018]

I Know First’s Past Success with CMG:

On May 1st, I Know First issued a bullish 1-month, 3-month, and 1-year forecast for CMG stock. The forecast illustrated a signal of 363.20 and a predictability of 0.37 for the 1-year period.


Current I Know First subscribers received this bullish CMG forecast on May 1st, 2018. 

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Conclusive Thoughts:

Chipotle’s well-received quarter wasn’t perfect. The driving force behind the positive comps was a 4.9% gain in the average check, largely as a result of menu price increases. In other words, the actual number of customers in that 2.2% rise in comps has actually declined. The $1.148 billion in revenue is a record for the first quarter, but the only reason it’s topping 2015’s performance is expansion. The chain has grown by 610 locations over the past three years. Unit-level sales remain well below where they were three years ago. Margins and earnings are also a sliver of what they used to be. Chipotle’s per-share profit of $2.13 is a little more than half the $3.88 it was sporting during the first quarter of 2015.

Most analysts still warmed up to the report. Chipotle may not be doing as well as it was three years ago, but it’s clearly taking steps in the right direction. Several Wall Street pros jacked up their price targets following the report, even one who downgraded the stock. Stephen Anderson at Maxim lowered his rating from buy to hold following the stock’s rally, yet he still raised his price goal on the stock from $410 to $435. Anderson argues that the stock’s sharp ascent over the past several weeks introduces more downside risk. It’s true that Chipotle isn’t a 70% better company than it was when it announced Niccol was taking over in mid-February, but the stock still trades 44% below its all-time high set in 2015. Chipotle has made mistakes, a lot of mistakes, but it’s back on track. Now it’s up to Niccol to introduce the operating improvements to beef up margins and the innovation to get traffic growing again.

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About Chipotle Mexican Grill Inc.:

Chipotle Mexican Grill, Inc. “Chipotle” (NYSE: CMG) , incorporated on January 30, 1998, together with its subsidiaries, operates Chipotle Mexican Grill restaurants. The Company’s Chipotle Mexican Grill restaurants serve a menu of burritos, tacos, burrito bowls (a burrito without the tortilla) and salads. As of December 31, 2016, the Company managed its operations and restaurants based on 11 regions. As of December 31, 2016, the Company operated 2,198 Chipotle restaurants throughout the United States, as well as 29 international Chipotle restaurants, and it also had 23 restaurants in operation in other non-Chipotle concepts. As of December 31, 2016, 29 of its restaurants were located outside of the United States, with 17 in Canada, six in the United Kingdom, five in France and one in Frankfurt, Germany. The Company sells gift cards, which do not have an expiration date.