Comparable Sales Look Good For Chipotle



Chipotle saw a nice sequential uptick in comparable restaurant sales during the second quarter, with much of the 5.5% increase stemming from ongoing peak-hour traffic throughput efforts as well as greater call-to-action marketing. Entering the quarter, there were concerns that competitive pressures (emergent fast-casual restaurant competition and more aggressive promotional activity from traditional quick-service and casual-dining players) might neutralize some of the throughput and marketing efforts, but the underlying comp rate of 4.5% (adjusted for one fewer day in the quarter compared to a year ago) outpaced the broader restaurant industry.

The market may be underestimating the long-term competitive threats that new fast-casual concepts across multiple cuisines present over a longer horizon, many have become more constructive about Chipotle’s comp prospects for the back of the year (even with management committed to holding the line on pricing) due to ongoing throughput and marketing efforts, expanded rollout of catering, new menu innovations like tofu-based Sofritas, and the closure of 67 Qdoba locations nationwide. Despite the encouraging top-line results, profits remained under pressure, with restaurant margins falling 150 basis points to 27.6% (due to elevated salsa, dairy, and poultry costs as well as higher marketing expenses) and total operating margins falling 150 basis points to 17.9%.

Expansion could prove more difficult at least through the third quarter with management setting full-year expectations of food costs as a percentage of sales “at or slightly above the 33% in the first quarter” and essentially ruling out price increases until 2014. Analysts remain optimistic about the long-term unit growth potential of Chipotle as well as the opportunity that ShopHouse and international expansion offer, and plan to incorporate a modest increase to the $310 fair value estimate based on the second-quarter trends. However, we believe the market’s implied long-term growth expectations may prove aggressive, with the company having little room for executional error with shares trading at 36 times our 2013 EPS estimate.

Chipotle is one of the clear leaders in the rapidly-expanding fast-casual restaurant category and remain confident that the company can outgrow the broader restaurant group for years to come. Some are encouraged by ongoing peak-hour throughput expansion efforts, a greater call-to-action in its marketing messaging, new menu innovations, and new channels of growth like catering, which collectively should keep comps in the mid-single-digit range for the remainder of the year (management noted that comp trends for July are keeping pace with underlying 4.5% growth in the second quarter).

However, with food costs as a percentage of sales expected to be “at or slightly above” 33% for the remainder of the year and management calling for a slight increase in labor costs as a percentage of sales, we’re forecasting approximately 60 basis points of restaurant-level margin contraction in the third quarter, implying 26.8%. That being said, assuming comp trends hold their current pace over the back half of the year, we expect margin trends to reverse in the fourth quarter against easier comparisons, resulting in slight margin expansion. Our updated model calls for roughly 60 basis points of restaurant margins contraction for the year (26.5% compared to 27.1%) and roughly flat consolidated operating margins (16.6% versus 16.7% a year ago).

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