On June 18, restaurant chain Chipotle Mexican Grill (NYSE: CMG) completed its highly publicized 50-for-1 stock split. Shareholders saw their $3,000 stock become 50 shares worth about $60 each.
Then, on July 24, Chipotle reported financial results for the second quarter, and the stock initially soared in after-hours trading. But once management spoke with analysts on the earnings call, the stock settled. While the Q2 headline numbers were great, there were concerns in the subsequent commentary.
Indeed, there were several things in the Q2 earnings call investors should be aware of. Here are two major takeaways.
Traffic trends are slowing
Chipotle’s headline numbers should be celebrated: Q2 same-store sales were up 11.1% year over year. That’s on top of the 7.4% gain in the year-ago quarter. And same-store sales were partially boosted by higher menu prices, but the company still enjoyed more than 8% growth in Q2 transactions, showing that traffic to its restaurants continues to climb.
While these impressive results should be commended, there is more to the story here. Management said its comparable sales were strongest in April. By June, growth had dropped to 6% with July coming in at a similar pace.
What could be driving the deceleration? It’s important to note that a social media trend emerged in May when many customers filmed their experiences at Chipotle, alleging that the company was skimping on portion sizes. Then, in June, Wells Fargo analyst Zachary Fadem ordered 75 burrito bowls, weighed them, and noted a wide disparity in portion sizes, which lent credence to customers’ complaints. This was all happening while comps were declining, which might be, as the great Yogi Berra once said, “Too coincidental to be a coincidence.”
Chipotle CEO Brian Niccol addressed this almost right out of the gate on the latest earnings call. He said hefty portion sizes are part of the company’s core brand identity, and he admitted management found outlier locations in its system that needed to be retrained. Consumers and investors should expect the portions controversy to quiet down going forward.
Profit margins could contract
Just like Chipotle’s consistently strong traffic growth, its profit margins should also be celebrated — the Q2 headline number was extraordinary. Increased restaurant traffic took its average unit volume for the previous 12 months to over $3.1 million, and this higher volume resulted in higher profit.
At the restaurant level, Chipotle had a Q2 operating margin of 28.9%, up from 27.5% in the prior-year period. For a restaurant company, this is top-tier profitability, but it may be peaking.
Rising prices have been a common theme in recent years. Since the pandemic began, inflation has driven costs higher for businesses and consumers. But since 2019, Chipotle’s profit margin has roughly doubled, suggesting prices went up far more than what was necessary to offset inflation.
The price increases at Chipotle are coming to an end for the time being. In the earnings call, management mentioned its last price increase was in October. Its expenses — labor and food — have continued to rise, but management isn’t planning another price increase right now.
This is an astute move given the company’s traffic trends are already decelerating. Raising prices now could further push customers away.
However, it’s also a problem for Chipotle since expenses are still going up. Therefore, management said it does expect its profit margins to modestly shrink going forward. Management is expecting a restaurant-level operating margin of 25% in the third quarter.
Again, it’s important to keep this in context: Chipotle boasts industry-leading margins. If they drop to 25%, they’ll still be top-tier. That said, investors may see earnings growth slow as a result.
What should investors do now?
It’s important to note that Chipotle stock hit an all-time high price-to-sales valuation of 9.3 in June. All of the company’s metrics were trending higher, motivating investors to bid the stock up to unprecedented valuation levels.
Now that some of its profitability metrics may decline, it’s reasonable to expect the stock’s valuation to revert to the mean.
While this could create some near-term pain for shareholders, things still look quite good for Chipotle long term. The company is opening new locations at a fast pace, and its restaurant volumes are still rising. These trends give the stock long-term upside, so while its valuation comes down, investors should keep Chipotle on their watch lists.
Don’t miss this second chance at a potentially lucrative opportunity
Ever feel like you missed the boat in buying the most successful stocks? Then you’ll want to hear this.
On rare occasions, our expert team of analysts issues a “Double Down” stock recommendation for companies that they think are about to pop. If you’re worried you’ve already missed your chance to invest, now is the best time to buy before it’s too late. And the numbers speak for themselves:
-
Amazon: if you invested $1,000 when we doubled down in 2010, you’d have $20,554!*
-
Apple: if you invested $1,000 when we doubled down in 2008, you’d have $41,185!*
-
Netflix: if you invested $1,000 when we doubled down in 2004, you’d have $340,492!*
Right now, we’re issuing “Double Down” alerts for three incredible companies, and there may not be another chance like this anytime soon.
*Stock Advisor returns as of July 22, 2024
Wells Fargo is an advertising partner of The Ascent, a Motley Fool company. Jon Quast has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chipotle Mexican Grill. The Motley Fool has a disclosure policy.
After Its 50-for-1 Stock Split Last Month, Here Are the Major Takeaways From Chipotle’s Latest Earnings Call was originally published by The Motley Fool
Source: finance.yahoo.com