Chipotle: Consumers may ‘trade out of the category entirely’ amid rising food prices, analyst says
Morningstar Analyst Sean Dunlop discusses Chipotle's latest earnings on Yahoo Finance Live.
- Chipotle earnings out, and you can see the stock off just about 5% here, after-hours adjusted EPS missing. $8.29, the estimate was for $8.91. Revenue growing 11%, but coming in in line with the Street's expectations at $2.2 billion. Fourth quarter comp sales up 5.6%. That missed the Street's expectations of growth of 7%.
All right. Let's talk more about these results with Sean Dunlop. He's Morningstar equity analyst. Sean, great to see you here. Certainly it doesn't look like the Street is satisfied with this report. What do you think?
SEAN DUNLOP: Yeah, I think what less than inspiring, as we took our first look at it. Missed on top line. Missed on bottom line. Missed on comp sales. And restaurant margins were a lot softer than we expected. So I think that's driving a big chunk of the reaction.
The other thing that's not brilliant is if you look at January comps. Obviously, in the low double digits, and they're guiding to high single digits for the full quarter. So they expect those to soften pretty materially as you move into February and March. So definitely keeping an eye on that.
One bright spot, if I get one, guidance for net new unit openings in 2023, 8 and 12% which is definitely an uptick. They've had some issues with construction and permitting.
- Digital sales up 37%. How significant is that in the positive column?
SEAN DUNLOP: Yeah, it's good to see that continue to-- that business to continue to operate at about double its pre-pandemic size. It's, I think, a slight sequential deceleration, or maybe level with the quarter before. But I would say that digital strategy is increasingly important as you move into 2023.
You're going to be able to maintain access with your customers, see how they react to pricing changes. It's a very dynamic environment. So that's something of a competitive edge.
- It certainly is a tough environment here, Sean. Brian Niccol, the CEO, saying in this earnings release that the company is facing a challenging and fluid macro environment. What do you think that means for Chipotle just in terms of the risk of some of their customers trading down to some of their competitors that are a little bit, I guess, cheaper and better priced for this environment?
SEAN DUNLOP: Yeah, it's a little bit of a funny sport. Is fast casual its own category, or are those customers sort of oscillating between fast food, fast casual, casual dining? And I would argue that Chipotle holds up relatively well. That particularly against that fast casual comp set, they're very price competitive.
But my fear is that on the margin you'll see some consumers perhaps migrate down into fast food as that price gap grows a little bit wider. You may even have some consumers trade out of the category entirely as you look at people belt-tightening, savings rates sort of in that 3%, 3 and 1/2% range. And what we typically see there is they might take a meal occasion that used to belong to a restaurant and push that to the grocery channel, which is usually cheaper.
- You have a hold and a price target of $1,560 on the stock. Anything caused you to change those?
SEAN DUNLOP: Yeah, unfortunately I can't preempt any price movements. What I will say is as we look forward into 2023, the story pivots from being about margin compression to being how long will it take for us to see margin recovery, even just to pre-pandemic profitability.
I think what this earnings report does is it suggests to us that pace may be slow, it may even be glacial for some operators. Very difficult to continue to raise prices ahead of the input cost inflation that we continue to see when your core customer is hurting.
- Sean, what about the loyalty programs? Because we know Chipotle has been very successful on this front, in this type of environment. How important is that, just in terms of driving future sales?
SEAN DUNLOP: Yeah. They've got a massive loyalty member base, in the ballpark of 30 million members. And that's particularly impressive when you consider that they only have about 3,200 stores in the US. The really important thing that the loyalty program allows you to do is it allows you to identify guests, it allows you to target them with offers if there's risk of them lapsing, as we typically see an environment like this one.
And it really lets you know in relevant time how customers are reacting to price increases, which items they're purchasing together, which items are playing particularly well in an environment that you might describe as almost recessionary. So I do think that the firms best positioned to win in 2023 are going to be those firms that compete well on value for the money, often QSRs. Also, those that have very strong touchpoints with their consumers, and you could look at Chipotle's the loyalty program and say that they fit that bill.
- Plans to announce hiring of 15,000 workers for burrito season, as we've been told. What's your biggest question for Brian Niccol on that call if you had one?
SEAN DUNLOP: Yeah. I'd be interested to see how they plan to grow top line in 2023. I mean, it's an environment where you can't lean on-- I think they took 14% to 15% pricing in the fourth quarter. You can't really do that again. Is it going to be an exciting LTO? Is it going to be tailored offers through the app? How are you going to continue to get customers in the store in '23? Because without that, it's going be very difficult to see margin recapture.
- Just speaking to that, the menu prices that we have seen, I think a lot of people are thinking that they might be priced out at this point. Do you think Chipotle is going to be forced maybe to raise their prices? And can they do that just given the state of the economy right now?
SEAN DUNLOP: Yeah. I think they'll be able to do that, but I think it will be a much slower pace than maybe we saw in 2022. So in the restaurant space, in December, we saw annual price increases in the neighborhood of 8 and 1/2%. I think next year you're probably looking at much closer to 5%. And when you juxtapose that against food-cost inflation in the neighborhood of 2 and 1/2 or 3%, sort of over the balance of year higher in the first half, and then hourly labor inflation in the mid-single digits, it gets very, very challenging to see restaurant margin expansion from here in the near term.
- All right. Sean Dunlop, appreciate that. Good stuff. Thank you, my friend.