Chipotle: Strong Q2 Earnings, But Will It Last?

On Tuesday afternoon, Chipotle Mexican Grill (NYSE:CMG) reported spectacular profit growth for the second quarter of 2022. Adjusted earnings per share (EPS) rose 25% year over year, reaching a new record high.

So far, high inflation doesn’t hurt Chipotle’s business at all. Still, investors may want to wait for confirmation that the fast-casual restaurant pioneer’s price hike isn’t alienating customers before jumping into Chipotle stock.

another good quarter

Chipotle reported 10.1% comparable sales growth for the second quarter: toward the low end of the 10% to 12% guidance range it provided in April. That still allowed it to post healthy top-line growth of 17%, bringing revenue to a record $2.2 billion.

Meanwhile, the menu price increase helped Chipotle offset rising costs, enabling the company to expand its restaurant-level operating margin from 24.5% to 24.2% to 24.2%. Chipotle’s overall operating margin expanded even more, as revenue grew faster than overhead costs.

As a result, adjusted EPS jumped to $9.30 from $7.47 a year ago, comfortably beating the analyst consensus. Investors were thrilled: Chipotle stock rose 15% on Wednesday.

revenue growth has slowed

During the company’s recent earnings call, Chipotle executives said that by mid-May, sales growth was on track to reach the upper end of the series’ 10% to 12% guidance range. Instead, growth slowed in the second half of the quarter.

CFO Jack Hartung attributed the slowdown to three factors: macroeconomic pressures, throughput issues related to staff turnover, and a return to normal season for Chipotle restaurants in college towns.

The latter two issues seem relatively harmless. Chipotle is stepping up its training efforts to improve productivity and throughput, which should reduce wait times and enable higher sales. Meanwhile, as students return to college campuses later this summer, sales growth at college-town restaurants should pick up again.

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However, the impact of inflation on the wallets of consumers can be a serious problem. While Chipotle’s customers tend to have a relatively high income, the chain is clearly starting to see some pressure on travel frequency. Comp sales growth has slowed to the mid-single digits this month.

planning a risky price hike

Despite these trends, Chipotle plans to increase menu prices by an average of 4% next month — on top of similar increases implemented in March 2022 and December 2021. Notably, effective pricing was already up about 10% year over year in the third quarter. of 2021. That means Chipotle would have increased prices by about 23% over a two-year period.

Image Source : Chipotle Mexican Grill.

On the one hand, Chipotle is facing rising costs due to widespread inflation. It needs to pass those cost increases to customers to continue expanding its profit margins.

On the other hand, raising prices when customer traffic is already slow is a dangerous move. As the higher costs of everyday essentials burn through consumers’ additional savings from 2020 and 2021, customer traffic trends could decrease even further, especially with Chipotle’s price hike again.

very expensive relative to the risk

I’m relatively optimistic about Chipotle’s long-term growth prospects. However, management can be very greedy regarding pricing.

If the chain doesn’t experience significant price resistance from customers, the upcoming price hike could help Chipotle continue strong earnings growth in the coming quarters. However, there’s also a worthwhile risk that Chipotle alienates some customers by raising prices again. If that happens, there’s no telling how long it might take for the company to regain its growth momentum.

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At a current valuation of 47 times its projected 2022 earnings, Chipotle stock seems too expensive to be a good bet, without much clarity on whether customers are willing to accept another price hike.

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Adam Levine-Weinberg has no position in any of the stocks mentioned. The Motley Fool has posts and recommends Chipotle Mexican Grill. The Motley Fool has a disclosure policy.

The views and opinions expressed here are the views and opinions of the author and do not necessarily represent those of Nasdaq, Inc.

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