The transition period following Brian Niccol’s departure at Chipotle Mexican Grill (CMG) has begun, marked by a challenging start for the company. Since missing the top-line estimates and recording its weakest earnings growth in more than two years, Chipotle’s shares have dropped by approximately 8%.
The company reported a same-store sales growth of 6%, contributing to a revenue increase of 13% to $2.79 billion, which fell short of the analysts’ expectation of $2.82 billion. The restaurant-level operating margin decreased from 26.3% to 25.5% due to increased food costs, particularly for avocados and dairy. Management noted that more ingredients were used in an effort to ensure “consistent and generous portions.”
Despite these challenges, Chipotle saved money on stock-based compensation following Niccol’s exit, which resulted in an operating margin increase from 16.0% to 16.9%. Consequently, earnings per share went up by 17% to $0.28, exceeding the consensus estimate of $0.25, though it represented the slowest earnings growth for the company over the past two years.
With Niccol now at Starbucks, Chipotle is at a critical juncture. Three key questions concerning its future need addressing by management to satisfy investors.
Firstly, the role of Scott Boatwright as the permanent CEO remains uncertain. Niccol’s departure, announced over two months ago and executed in September, saw Boatwright, the Chief Operating Officer, step in as interim CEO. Investors are eager for clarity regarding Chipotle’s leadership, with some suggesting that Boatwright’s continuation could be beneficial given his critical involvement in the company’s previous turnaround strategy. The company has indicated that Boatwright would continue executing the strategic plan without any disruption.
Secondly, the potential ceiling for Chipotle’s restaurant-level operating margin needs exploration. Historically, Chipotle has seen growth in this area, but a recent decline from 26.3% to 25.5% poses questions. While Chipotle hasn’t set a target for this margin, the prevailing assumption among investors is that it should continue to rise, especially with increasing same-store sales. With the company’s high price-to-earnings ratio, there is significant investor interest in understanding long-term margin expectations.
Lastly, the company’s strategy for capital allocation is under scrutiny. Currently, Chipotle allocates most of its profits to share buybacks, a strategy that comes into question given the company’s high valuation. Previous attempts to launch new brands have not been successful, although opportunities exist in investing in current restaurant chains or new technologies. Alternatively, Chipotle might consider paying a dividend to complement its share repurchase program. The incoming CEO will need to address these capital deployment strategies.
In terms of investment, Chipotle, despite its premium valuation, uncertain leadership, and slowing earnings growth, remains a strong company. The aim is to open 7,000 restaurants in North America, almost doubling its current number. Hence, robust comparable sales growth is necessary for the stock to justify its current valuation. Given its leading position in the fast-casual industry, Chipotle continues to be a solid choice for long-term investors, although more clarity from management on the aforementioned concerns—and potentially a lower share price—would be prudent before considering the stock a strong buy.
