Simulated Best Ideas Newsletter portfolio idea Chipotle raised its 2018 comparable restaurant sales guidance after a strong second quarter revealed the effectiveness of menu price hikes.
By Kris Rosemann
Once beaten down Chipotle (CMG) appears to have found its way back into the good graces of consumers. The fast casual burrito restaurant’s second quarter results, released July 26, showed a continued decline in traffic (comparable restaurant transactions fell 1.8% from the year-ago period), but a 4% menu price increase helped drive average check growth and ultimately a 3.3% year-over-year increase in comparable restaurant sales in the period. Total revenue advanced 8.3% from the second quarter of 2017 thanks in large part to new restaurant openings, and the company has more room to run in expanding its store base.
While new CEO Brian Niccol is deservedly attracting attention for his pushes in menu innovation and a potential expansion into breakfast, digital initiatives are offering another potentially meaningful growth avenue. Digital sales leapt 33% in the second quarter on a year-over-year basis, which accelerated from 20% growth in the first quarter of 2018, and now account for 10.3% of sales. Management believes this is a multi-billion dollar opportunity, suggesting material growth is in store as its current annual digital sales run-rate is estimated at $0.5 billion, which should be enhanced by the roll out of digital pickup shelves as such a feature remains in certain test markets. Mr. Niccol also noted that, “mobile and delivery orders are in that $16 to $17 range versus our traditional check is in the $12 range.”
Chipotle’s second quarter margin performance was another bright spot as its restaurant level operating margin expanded 90 basis points from the comparable period of 2017 as higher comparable restaurant sales, lower food costs as a percentage of revenue, and lower marketing and promotional spend were partially offset by wage inflation, the latter of which is not going away anytime soon. GAAP net income faced pressure (down nearly 30% year-over-year) in the quarter as a result of one-time charges related to restaurant impairment, corporate restructuring, and certain legal costs, but adjusted net income, which excludes these charges, grew 20.2% from the year-ago period.
Through the first six months of 2018, Chipotle’s free cash flow generation has been solid, growing more than 28% from the year-ago period to $167 million. As of the end of the second quarter, the company held no debt on the books compared to a cash balance of nearly $226 million. We love the fact that the company has been able to fund its growth with internally-generated cash flows.
Following the second quarter, Chipotle raised its 2018 comparable restaurant sales growth guidance to the low- to mid-single digit range, up from prior expectations of low-single digit growth as menu price hikes take hold. New restaurant openings are now expected to be near the low end of previous guidance for 130-150 openings, but this should not impact the long-term trajectory of restaurant openings.
We continue to like shares of Chipotle, and comparable restaurant sales have the potential to turn even higher should the company make a successful entrance into the breakfast market and digital initiatives continue to gain steam. Strong execution in these areas coupled with solid margin performance, which is outside management’s control to a degree as it relates to food and wage costs, could push Chipotle towards the upper end of our fair value range as our current fair value estimate sits at $459 per share.
Related: YUM, YUMC
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.