CMG Has Einhorn Smelling Like Roses Again

by Alyssa Oursler | October 19, 2012 11:19 am

I think it’s pretty safe to say that David Einhorn is doing a little dance and munching on a celebratory Cantina Bowl today.

If you recall, the legendary investor earlier this month had suggested that Chipotle Mexican Grill (NYSE:CMG[1]) was likely to struggle thanks to Taco Bell’s push into the premium market[2]. Investors took note, sending the growth darling down around 7% … but the more noticeable response was the laughter coming from the general public.

After all, everyone believes Taco Bell’s appeal is low-cost, pandering to the likes of college kids craving late-night eats — hence the blowout success of its Doritos Loco Taco — and thus usually is mentioned in the same questionable-quality breath as McDonald’s (NYSE:MCD[3]) and Burger King (NYSE:BKW[4]). Just because Taco Bell traded in a chihuahua for a celebrity chef and debuted a fast-food rip-off of Chipotle’s burrito bowl doesn’t mean it is inching onto the premium restaurant’s turf, right?

Well, today, shares of CMG plummeted double-digits after the company missed expectations for earnings and revenue[5] and same-store sales slowed. For good measure, Taco Bell parent Yum! Brands (NYSE:YUM[6]) jumped last week on better-than-expected earnings and strong same-store sales. Helping bolster the lunch crowd? Cantina Bell[7].

Einhorn just might get the last laugh after all.

From an investor perspective, he hit at least the intended result on the head. CMG shares were off nearly 14% of the open, bringing Chipotle’s year-to-date losses to more than 27%.

And while folks can go ahead and keep mocking the Taco Bell-Chipotle comparison from a consumer perspective — there wasn’t anything in the company’s earnings report that actually proved Chipotle is being hindered by Lorena Garcia’s creations — there’s still plenty of time for his theory to play out.

In fact, one detail in Chipotle’s conference call might play right into Einhorn’s argument: The company might be raising prices. According to CFO John Hartung:

“We don’t have any specific plans to increase menu prices next year, but with inflationary expectations related to the summer drought looming, which I’ll talk about later, we remain open to possibility of a price increase next year. …

“So the combined inflation in Q4 and next year is expected to be in about the mid-single-digit range. Should that kind of inflation materialize, we will consider price increase to help offset the impact.”

Food, beverage and packaging costs rose 17% in the latest quarter, and food inflation could only make things worse. The chain already increased menu prices on the West Coast as a result, and said it wouldn’t rule out more of the same.

Increased input costs alone are problematic as they deflate margins, and while the obvious fix is to counter with higher prices, this could really go awry.

A steak burrito meal for almost 10 bucks is pushing it as is — and Chipotle recognized that consumers have been spending cautiously. If the chain’s menu gets any pricier, even loyal fans might consider flocking to the lower-priced Cantina line, where offerings don’t even break the $5 mark.

Whether that actually will play out remains to be seen. But for now at least — regardless of the whys and hows — Einhorn is coming out looking a lot smarter than he did a few weeks ago.

As of this writing, Alyssa Oursler did not hold a position in any of the aforementioned securities.

  1. CMG:
  2. thanks to Taco Bell’s push into the premium market:
  3. MCD:
  4. BKW:
  5. missed expectations for earnings and revenue:
  6. YUM:
  7. Cantina Bell:

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