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Chipotle Mexican Grill, Inc. (CMG): This Cinderella Story Is OVER

CMG isn't able to pass on enough of its increased costs to the customer

Shares of Chipotle Mexican Grill, Inc. (CMG) were getting absolutely clobbered on Wednesday morning, losing more than 7% in early trading.

Chipotle Mexican Grill (NYSE: CMG)Despite third-quarter revenue coming in exactly where analysts expected, at $1.22 billion, and a narrow beat on same-store sales growth (2.6% vs. consensus 2.5%), CMG stock plummeted as the burrito chain with a cult-like following missed on earnings.

Wall Street was looking for $4.62 in adjusted EPS; CMG was only able to deliver a profit of $4.59 per share.

At first glance, missing several-dollar EPS estimates by a few pennies doesn’t seem like such a big deal. But it actually is — and yesterday’s report merely confirms what has gone largely unsaid for much of 2015:

CMG stock’s remarkable multiyear run is over.

Chipotle Stock: Average at Best

The “problem” with the Chipotle earnings report was a cost control issue. Seeing as revenues came in on par with Wall Street’s expectations, margin contraction was the reason for the EPS miss.

This sort of thing could be a lingering problem for CMG stock — and others in the retail and restaurant industries — as a push for higher minimum wages gains national traction.

Since President Barack Obama called for Congress to raise the federal minimum wage from $7.25 an hour to $9 an hour in his 2013 State of the Union address, 13 states and the District of Columbia have raised the state minimum wage.

As a Washington, D.C., resident myself, I noticed how Chipotle was dealing with this firsthand: by passing on the cost to the consumer. In a single transaction, you can see why rising labor costs are a huge impediment to CMG stock going forward:

A steak burrito at Chipotle used to run $8.25, with tax, in D.C. One fine day a few weeks ago, I strolled into my local Chipotle, innocently ordered a steak burrito, and, mid-thumb-twiddle, was informed that my bill came out to $9.

I voiced my shock to the employee, who said the price increase was due to higher minimum wages. I reminded myself not to buy any shares of CMG stock, took my burrito, and happily devoured it.

By going from $8.25 to $9.00 a burrito, CMG is taking in 9.1% more from the customer. I like Chipotle enough that a 9% jump in menu prices won’t keep me away. However, that’s not true for every Chipotle customer, not to mention it doesn’t even cover the increase in minimum wages, which rose 10.5%, to $10.50 an hour, from 2014 to 2015.

Next year, I suspect that D.C. Chipotles will have to raise their prices once again, as the minimum wage increases another $1, or 9.5%, to $11.50 an hour. Every year this continues, Chipotle is at greater risk of some customers saying enough is enough.

The minimum wage movement is ostensibly one of the reasons that Walmart (WMT) — after having announced in 2010 that it would go from 2.2 million employees to 3 million employees by 2015 — remains at a 2.2 million headcount today.

A proposed increase in the minimum wage to $15 an hour was ridiculed by Dunkin Brands (DNKN) CEO Nigel Travis as “outrageous,” and said it would prevent his company from making new hires.

Regardless of one’s political leanings, the numbers don’t lie, and CMG’s bottom line is feeling the pain from higher labor costs. Restaurant-level operating margin dropped 50 basis points year-over-year to 28.3% last quarter.

And even if we make the generous assumption that CMG can pass on all of these cost increases to the customer, it still has to deal with sluggish same-store sales growth, which was actually the factor that most concerned me going into the Chipotle earnings call yesterday.

After all, same-store sales growth of 2.6% is a far cry from the blistering 19.8% figure we saw in the same quarter a year ago.

At a forward price-to-earnings ratio of 31, CMG stock is still trading like a best-in-class growth stock. But times are changing, and in light of higher labor costs and slumping same-store sales growth, I’d be shocked if Chipotle stock outperformed the market over the next three years.

As of this writing, John Divine did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @divinebizkid or email him at editor@investorplace.com.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/10/chipotle-mexican-grill-inc-cmg-stock-2/.

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