We believe investors should walk away from Chipotle's (CMG) third-quarter update with optimism, as it's clear that new CEO Brian Niccol is delivering early returns with several intriguing initiatives left in the pipeline.
While there's no denying the potential appeal of new menu items, restaurant formats (including drive-up windows), and a new loyalty program, it's the ability to execute basic functions like advertising and throughput that was the most impressive takeaway and helps to reinforce the brand behind our narrow moat rating.
While comps of 4.4% were slightly behind Wall Street expectations of 4.9%, it tells us two things. One, the new "For Real" advertising campaign is connecting with consumers while helping to nullify the well-publicized food-safety incident in Ohio. Comparable transactions were flat, but barring a more pronounced economic downturn, we believe transaction growth should turn positive in the fourth quarter with comps remaining in the mid- to high single digits over the near future. Two, digital orders (up 48% to 11.2% of total sales) and delivery are benefiting store-level utilization and should eventually drive greater operating leverage. As it optimizes mobile order and delivery, we believe Chipotle will be positioned to introduce new products like quesadillas, nachos, avocado tostadas, and chocolate milkshakes that should stimulate consumer curiosity without adding undue operational complexity.
While management did not provide full 2019 guidance, we were encouraged that it is planning for a modest increase in store openings (140-155 versus 130-150 in 2018, less the previously announced 55-65 closures). We would not be surprised to see market optimism prop up Chipotle's stock as comps accelerate, though we're only planning a modest increase to our $400 fair value estimate, which already assumes restaurant margins and operating margins will recover to the low to mid-20s and the low to midteens, respectively, over the next five years.
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R.J. Hottovy, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.