It looks like increased competition is starting to take a significant toll on Chipotle (CMG).
One of the first popular fast-casual dining chains that serves all-natural food, Chipotle has a lot more competition in the space than it did a few years ago.
Chipotle earnings, released last night, indicated that these competitors are starting to really take a big bite out of the burrito chain’s growth.
Sure, CMG is soaring today, but don’t be fooled. Investors should sell their Chipotle stock into today’s strength, as the competition is probably going to intensify in coming quarters and could cause Chipotle earnings to weaken significantly going forward.
That assessment might seem inconceivable for a stock that has CMG’s five-year history, but the devil’s in the details, and the details aren’t good for Chipotle stock.
Chipotle Stock Is Losing Steam
CMG reported that its second-quarter same-store sales rose 4.3% last quarter, well shy of analysts’ consensus estimate of 5.7%, according to CNBC. Moreover, the comp sales increase was down considerably from last quarter’s 10.4% gain and the 15% jump during the same period in 2014. CMG expects its same-store sales to rise by low- to mid-single digit percentages this year.
Chipotle earnings came in at $4.45 per share of Chipotle stock, one cent above the consensus estimate, as CMG benefited from easing dairy and avocado costs. But the burrito chain reported revenue of $1.2 billion, slightly below the consensus outlook of $1.22 billion.
More ominously for Chipotle stock, the company said that most of the comparative store sales gain that it did register last quarter was driven by an increase in the average amount that customers spent at the restaurant. That increase, it appears, was largely triggered by a price hike that the company implemented last year.
In other words, the number of customers who eat at Chipotle is no longer increasing meaningfully. Instead, the burrito maker is relying on price increases to boost its comp sales. The bad news for CMG is that, although the company said that it had increased its prices again this month and had not seen any negative effects from the hike, it probably cannot continue to raise prices every year going forward without seeing its customer traffic drop significantly.
Chipotle’s After-Earnings Jump Is a Selling Opportunity
Despite the sizable comp sales miss, CMG is soaring today. According to the buzz on the Street, Chipotle stock is jumping because the company said on its conference call that the number of transactions at its restaurants had risen by low single digit percentage levels. As a result, many investors seem to believe that the company’s traffic problems are behind it.
But a few weeks is a relatively low sample size on which to identify a trend, let alone make an investment decision. And let’s not forget that, in its own news release, Chipotle pointed out that “Comparable restaurant sales growth was driven primarily by an increase in average check…and to a lesser extent increased traffic.” Menu price hikes are still doing the bulk of the lifting.
And Chipotle won’t be able to rely on raising prices every year, not with the way competition is increasing. The number of fast casual restaurants serving all-natural food geared toward millennials is increasing rapidly. Shake Shack (SHAK), Five Guys, Saladworks, and Habit Burger (HABT) are just a few of the companies in this category that are quickly expanding their footprint.
Additionally, the same-store sales of Yum Brands’ (YUM) Taco Bell jumped 6% last quarter, outpacing Chipotle’s 4.3% increase. Although some of the increase in Taco Bell’s sales was due to its introduction of breakfast this year, the magnitude of the increase, combined with Chipotle’s disappointing earnings, suggests that Taco Bell might be stealing some CMG customers who are tired of paying Chipotle’s high prices.
And then there’s the valuation of Chipotle stock, which is trading at about 34.5 times analysts’ 2016 consensus EPS estimate. That seems really rich for a restaurant chain whose same-store sales might only rise a few percentage points this year. And today’s 8% jump only worsens the problem.
The bottom line: CMG’s slowing same-store sales growth, mounting competition, and high valuation make Chipotle stock very risky, with an unattractive risk/reward profile.
As of this writing, Larry Ramer did not hold a position in any of the aforementioned securities.
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