Chipotle's Savory Problems

 | Jan 17, 2013 | 12:30 PM EST  | Comments
  • Comment
  • Print Print
  • Print
Stock quotes in this article:

cmg

Mexican-style restaurant chain Chipotle (CMG) delivered preliminary fourth-quarter results this week that sent shares down 5%.

If only shares had fallen further. In fact, I hope shares decline plenty more in the next coming weeks, as I would love nothing more than to get another bite at that burrito. Chipotle suffers from what I would say are good problems by any definition.

The first problem is that many stores are losing customers during lunch -- but this is because they're seeing such high store traffic that Chipotle's trademark fast service is being jeopardized. The long-term answer is that Chipotle will start to open more restaurants in the same city. High-volume locations in cities like Greenville, S.C. could easily support restaurants a few miles apart. In the short run, Chipotle will just have to continue refining what it does best, which is to serve people very quickly. I will say that I've been to numerous restaurants in different states, and even the busiest ones still manage serve patrons in a reasonable time during lunch hour.

I'm not sure if the new catering initiative will actually do anything to defray lunchtime traffic, as the minimum catering order is for 20 people. But I do think catering is a brilliant extension for a business like Chipotle. I think that, over time, Chipotle's catering business is going to be an additional growth driver with far higher margins than what its menu items offer.

Chipotle's second problem is the biggie -- food costs increased by 130 basis points in the fourth quarter. But, in my view, Chipotle can easily overcome this issue, as I believe it currently has tremendous pricing power. In most markets, the average menu price of a burrito or burrito bowl is $6.50 -- and, with a drink, you're looking at between $8 and $9. I'm not a big fast-food eater, but when I went through a McDonald's (MCD) drive-through to get my a wife a cup of coffee, I was surprised to see that a Quarter-Pounder meal at will now set you back $5 to $6. A meal at Chick-fil-A can cost anywhere from $6 to $8.

I've always said Chipotle was a fine meal, served cheap in a tortilla. For the quality of food it serves, I think the menu prices are dirt-cheap. The company has also done a marvelous job of marketing its food and. I believe that, as a result, the customer base is highly loyal -- comprising individuals, like myself, who care about the quality of food that they consume and are willing to pay up for that quality. Most people go to Chipotle because they want Chipotle -- not because they want a burrito. For an analogous company, during the recession many questioned the future of Whole Foods (WFM) selling highly expensive food to a cost-conscious consumer. Yet the company has been growing its top line ever since.

I think the Chipotle could easily add $0.25 to each main menu item without missing a beat. In fact, it has already increased costs once in the past two years, and the problem is still too much traffic during lunch. At Panera Bread (PNRA) -- which is a good comparison for Chipotle, given the characteristics of its typical customer -- a meal can easily cost $9 to $10 per person.

Chipotle's issue of too much foot traffic is somewhat ironic. If a hypothetical price increase were to turn away some customers, I believe they would be replaced by others waiting in the wings. I think that, to a certain extent, the market believes this as well. After all, even after the company indicated that earnings per share would be $1.95 for the fourth quarter -- below estimates of $2.10 -- shares dropped only 5%. In most cases, such a miss would be enough to send Mr. Market sprinting for the exits.

In any case, if shares do fall another 15% to 25% in the coming months, the stock will be just as tasty as the food. 

Columnist Conversations

Since Tuesday's low at 12.12, the VIX (SPX Volatility Index) has climbed to a high of 16.14, up nearly 34%. Mo...
I have a major support decision in IWM I will most likely write Friday's article on. As usual, wait for trigge...
Several large cap stocks are holding up better today than their beta-adjusted expected returns: BMY, PM, BA, K...
If you took the short side against the time/price resistance in ICE recently, trail stops down as you go...esp...

BEST IDEAS

REAL MONEY'S BEST IDEAS

Columnist Tweets

BROKERAGE PARTNERS

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data provided by Interactive Data. Company fundamental data provided by Morningstar. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by Interactive Data Managed Solutions.


TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

IDC calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.