Chipotle Establishes 2018 as a Transition Year
Investors need to focus more on longer-term unit potential after results that were bogged down in the third quarter.
Chipotle's (CMG) third-quarter update effectively served as a reset, where it embarked on aggressive steps to improve brand relevancy amid an evolving restaurant landscape. Not surprising, third-quarter results--including comps of 1% (against a 21.9% decline a year ago), restaurant margins of 16.1%, and operating margins of 2.7%--were dragged down by publicity surrounding a norovirus and other health issues early in the quarter, the impact of a data security breach, and hurricane-related closures, partly tempered by the nationwide launch of queso. However, we believe investors need to focus more on longer-term unit potential, whether consumers will respond to new products and in-store enhancements, and digital platform improvements, as they hold the key to Chipotle's longer-term cash flow potential and our narrow moat rating.
While the decision to pull back 2018 store openings to 130-150 (versus a five-year average of 200) certainly calls into question its ultimate store potential--we still forecast 4,000 versus management's target of 5,000--we believe it is prudent to adopt a more prudent pace store opening schedule while focusing on customer experience and digital/store utilization initiatives. While Chipotle's other sales drivers are a show-me story, we think the generally positive consumer response to queso (which has had a 4%-6% comp benefit since launch despite reports of tepid consumer reaction) bodes well for future beverage, dessert, and salad innovations. Additionally, mobile ordering, utilization of its second assembly line, and a 5% price increase in 900 restaurants in November offer support for our outlook for 2%-3% comps in 2018.
We plan to trim our near-term top-line growth and margin assumptions, reducing our $400 fair value estimate by 5%-10%. While investors must be willing to accept some quarter-to-quarter volatility, we believe Chipotle may be worth a look for longer-term investors now that we have greater visibility about what to expect in 2018.
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R.J. Hottovy does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.