Chipotle: Leaning Into Digital
Chipotle Mexican Group Inc. (NYSE:CMG) recently reported results for the first quarter of fiscal 2020.
Revenues in the quarter increased 8% to $1.4 billion, attributable to 5% growth in units (ending the quarter with 2,638 locations) and a 3.3% increase in comparable store sales (comps). The increase in comps was driven by a 5% jump in ticket as a result of menu price increases implemented in 2019 and a higher mix of digital orders (which have a higher average check), offset by a 1% reduction in transactions. It is worth noting that the quarter benefited from an extra day, with adjusted same-store sales up roughly 2% year over year.
Within the quarter, there were two distinct periods. Through the first two months, comps increased by more than 12% (adjusted for the extra day benefit) on the back of strong transactions growth. But as the impact of Covid-19 took effect, there was a significant step down in the results: in March, the final month of the quarter, comps declined in the mid-teens. In addition, as outlined in the press release, that continued into April, with the commentary suggesting that comps in the past few weeks have (cumulatively) been down more than 20%.
Overall, we can see that the net result was a material slowdown from recent quarters.
Non-traditional orders (i.e., not standing in line) continue to drive meaningful growth for Chipotle. In the first quarter, digital sales were up 81%, accounting for 26% of the company's sales. That works out to roughly $370 million in the quarter - compared to a digital business that generated $250 million in revenues for the whole year in 2017. In March, when Covid-19 started to materially impact the business, digital orders more than doubled year over year, accounting for nearly 40% of Chipotle's sales.
As CEO Brian Niccol noted on the call, they leaned into digital as conditions changed:
"As people started to implement social distancing, we moved swiftly by driving further investments towards digital and delivery designed to reduce friction while increasing convenient access. Although Queso Blanco is off to a terrific start, we reprioritized our marketing efforts by offering free delivery... We also announced a successful national delivery partnership with Uber Eats that is helping drive new customers and greater frequency. Collectively, these decisions translated into strong engagement with our guests... A recent survey among current Chipotle consumers suggest that about 15% had Chipotle delivered for the first time during the last two weeks of March... We believe this will have a lasting benefit well beyond the current crisis and are pleased to report that we have maintained strong momentum into April... digital is currently accounting for nearly 70% of sales."
The company continues to see strength in the non-delivery parts of its digital business as well (order ahead, including Chipotlanes). Previously, the company planned on opening 150 to 165 new stores in 2020, with the majority having Chipotlanes. Given the recent change in market conditions, they have pulled that guidance. And while unit growth may ultimately fall short of 150 new units for the year, the company clearly remains optimistic on its digital investments: "We continue to shift our development pipeline more aggressively towards Chipotlanes... As a result of the continued strong performance of Chipotlanes and less competition for new sites, we will seek even greater proportion of Chipotlanes in our pipeline, which will enhance customer access and convenience, and increase new restaurant sales, margins and returns."
As a result of the significant headwinds in March, restaurant level margins declined 340 basis points to 17.6% (margins were up year over year in January and February). This more than offset the increase in revenues, with non-GAAP earnings declining 9% in the quarter.
In terms of the balance sheet, Chipotle remains well positioned with more than $900 million in net cash and investments at quarter-end. The company repurchased $54 million of its stock in the quarter, but ultimately suspended repurchases in late March ("we have no plans to restart the buybacks in the near-term"). Considering where the stock currently trades and the fact it is experiencing material short-term business headwinds, I think that's an intelligent decision.
Conclusion
I think the results through the first two months of the year suggest Chipotle is continuing to fire on all cylinders. What they're doing is working. And while the pandemic will continue to impact the business results in the short term, the company has shown it is in a better position than most of its restaurant peers to weather the storm.
The problem for me continues to be the valuation, not the business. The stock closed on Wednesday at $897 per share, or 64 times trailing earnings (who knows on forward earnings). As a reminder, there will be significant operating leverage if the company continues to deliver outsized same-store sales growth. If average unit volumes (AUVs) increase from $2.2 million to $2.5 million (roughly where it peaked in 2015), management believes margins will expand significantly. That would result in substantial earnings growth - along with a reduction in the earnings multiple.
Based on my research, this future improvement is largely accounted for in today's stock price. My estimate of earnings five years out, before accounting for the impact of Covid-19, was around $40 per share. Said differently, the stock is trading at 22 to 23 times earnings five years out - and that assumes things continue to go as planned over that period. Simply put, the amount of optimism implied at the current valuation remains too high for me.
Here's Niccol with the last word:
"No one can predict the magnitude or duration of this crisis, but we are focused on winning today, while we cultivate a bright future for our employees, guests, communities, and shareholders. By staying calm and working collaboratively to leverage our strong brand, business model and balance sheet, we are confident in our ability to get through the current downturn... Chipotle is well prepared to regain our prior momentum and expand our brand leadership... I think the strength of our brands, our balance sheet and our digital business is going to set us up very nicely on the opportunities that present themselves as we get to the other side of this."
Disclosure: None.
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