Fast casual Mexican eatery Chipotle (NYSE:CMG) reported first-quarter numbers on Apr. 24 that smashed expectations across the board, causing multiple analysts to raise their price targets on CMG stock.
The Potential Chipotle Stock Rebound Is All About Brian Niccol
Revenues and profits beat analysts’ consensus expectations. Comparable sales growth was higher than expected, and the highest it’s been in a long while. The same was true of the company’s digital-sales growth. Its margins expanded by more than expected, and its full-year comparable sales guidance was hiked.
That’s because, with CMG stock sporting a 50-times forward earnings multiple, versus restaurant stocks’ average forward multiple of 25, CMG stock is priced for perfection. As a result, CMG needs perfect numbers and perfect conditions to work now. Anything less than perfect will cause the shares to be weak.
CMG’s first-quarter numbers were pretty close to perfect. But there were some concerns regarding the company’s disclosure in an SEC filing that it had been served with another subpoena from the Department of Justice related to a probe into the multiple food-borne illnesses that have struck Chipotle. Investors latched onto that disclosure and sold CMG stock.
It’s true that CMG stock has slightly rebounded since the report. But its initial decline should be seen as a warning shot for investors. Chipotle reported near-perfect numbers, and because of a largely irrelevant subpoena related to old issues, CMG stock dropped by a large amount. When CMG doesn’t report near-perfect numbers, Chipotle stock will drop by much more.
Because of that, investors should tread carefully with Chipotle stock. It is priced for perfection, and that makes it susceptible to a huge pullback on any hiccup.
Chipotle’s Comeback Is for Real
In general, CMG’s strong first-quarter numbers affirm that the turnaround story at Chipotle is not only alive and well, but as robust and vigorous as it’s ever been.
For the fifth consecutive quarter, CMG’s comparable sales growth accelerated higher. Its comp sales rose 9.9%, which is an impressive mark for any quick -service restaurant. It’s even more impressive considering that it lapped against up 2.2% comps in the year-ago quarter. So on a two-year basis, its comps have risen by double-digit-percentage levels.
Perhaps more importantly, the comparable sales gains have been driven by two things: an uptick in its traffic, and its expansion of its digital business. CMG’s traffic rose by nearly 6% in the quarter, up from a 2% increase in Q4 and coming after negative traffic growth through the first three quarters of 2018. Its digital sales rose by more than 100%, up from about 50% two quarters ago and about 65% last quarter. Thus, the company’s new growth initiatives to drive customers back into its stores and expand its digital reach are working really well.
Of equal importance, its margins are expanding, while its top-line momentum has increased. CMG’s restaurant-level margins expanded 1.50 percentage points in the quarter, reaching multi-quarter highs, and should continue to rise for the foreseeable future.
Overall, then, Chipotle just reported its best numbers in recent memory, against a difficult comparison, thereby broadly confirming that its comeback remains robust.
Slowing Growth Could Derail the Rally
The problem with CMG stock isn’t the legitimacy of Chipotle’s operational comeback. Rather, as I mentioned earlier, the problem is that CMG stock is so richly valued that any hiccup will cause a big drop in the shares. Such a hiccup looks likely to happen in 2019.
Specifically, Chipotle’s numbers are now hitting their best levels in multiple quarters. But those numbers will inevitably slow as 2019 wears on. The comparisons will get harder as the year progresses. Comp sales growth started out 2018 at 2%, and reached 3% in Q2, 4% in Q3, and 6% in Q4. Also accelerating during the same period were its traffic trends and digital sales, which will have fairly tough comparisons by the end of 2019. Thus, as comparisons get harder throughout 2019, it is only natural to assume that CMG’s growth will slow.
Furthermore, CMG’s margin expansion will slow, too. Restaurant level margins expanded only 1.5 percentage points in the first quarter of 2019. Throughout all of 2018, restaurant-level margins expanded 1.8 percentage points, and the rate of expansion in the back half of 2018 was north of two percentage points. Thus, CMG’s margin expansion is already slowing and should continue to slow as its wages move higher and its margins get closer to their pre-E. coli highs.
Overall, then, Chipotle’s growth rates should come down throughout 2019. As they do, CMG stock will likely fall, too, because it is priced for perfection, and a growth slowdown is far from perfection.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
