Wednesday after the close, Chipotle earnings were released. The company turned in some very impressive results with revenue of $388.8 million (up 14.1% from last year) and earnings of $1.10 which handily beat consensus estimates. The second quarter earnings were actually 48.6% higher than last year which one would think would have a positive effect on the stock.
As I write, a few minutes before the official market open, CMG is trading down $3.50 or so in pre-market trading. This despite the fact that the broad S&P and Dow futures are pointing to a slightly higher open for equities in general. It appears that behind the Chipotle earnings headline number, there are a few details which have investors concerned.
One of the metrics which management appears to be most proud of is the strong operating margin of 26.0%. This is a full 360 basis points higher than the company saw last year and was driven by three main factors. First, there was an increase in menu prices which began showing up in the numbers a couple of quarters ago. In the second quarter of 2008, however, the menu prices were still at their old levels. Secondly, the company has been able to use its labor more efficiently (cutting back on wages or the number of hours worked) which certainly helps to keep costs low. Finally, the company significantly cut back on marketing and promotional spending which had a temporary effect of reducing expenses.
While the end result was impressive, the means to get TO this earnings level appears unsustainable. Obviously if you significantly cut marketing and promotional spending, over a short period of time you will begin to see sales dwindle. For that reason, management noted that 2009 marketing spending will mirror 2008 as a percentage of revenue. And since the second quarter was so light in this area, you can bet that the promotional spending will be very high in the third and fourth quarter. This will drive margins lower.
At the same time, management is guiding for 120 to 130 new store opeingins in 2009. With only 50 completed in the first half, that means investors can expect at least a 40% increase in new store openings in the second half. These new stores typically have lower margins until they have been opened long enough to become well established, and there are significant store opening costs associated with the locations.
Analysts are currently expecting earnings of $3.05 for 2009 and $3.53 for 2010 although I have already started seeing some revisions higher. Still, with the stock near $90 (actually closer to $85 this morning) it appears that investors are pricing in solid growth. What investors may be overlooking is the risk to margins associated with the new openings and higher spending on marketing, as well as the difficult consumer environment.
A generous multiple of 20 times 2010 earnings would put the stock at $70, and I expect that if the recent rise in the market begins to stall, the multiple on a growth stock like CMG could quickly drop to 15 which would bring the price much closer to $50.
So far our catuion on CMG has been a bit early as the stock has remained rangebound since our May 7th article. But after more than doubling from its low, the stock looks vulnerable and will likely have difficulty providing any positive returns for investors over the next several quarters.
FD: Author does not have a position in CMG
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