Burrito Alert? Why Concerns Over a Planned Price Hike Are Obscuring an Otherwise Great Quarter for Chipotle

Chipotle's (NYSE: CMG  ) move to raise prices dominated the news coming out of its first-quarter earnings report. BusinessWeek's headline called for a "Burrito Alert: Chipotle Is Raising Prices." NBC announced: "Holy Guacamole! Chipotle to Raise Prices as Costs Soar," while Quartz seemed to imply that customers are already paying a high premium, with a headline, "Your precious Chipotle burrito is about to get more expensive."

This will be Chipotle's first price hike in three years, and the company has become a lot more popular over that time, so it's reasonable that news outlets played it up. But with the stock dropping to nearly 17% off its recent highs, concern over the pending hike seems to be obscuring what was otherwise a very solid quarter for the country's favorite burrito maker. Besides, the price hike may not be as big a deal as it seems. More on that later.

Source: Chipotle.com

On the downside, the first-quarter call brought word of the price hike, lots of talk about increasing food costs, and a weaker-than-expected earnings number. (Think those three things may have anything to do with each other?) But there was also plenty of good news for investors to chew on, and still more evidence of just why Chipotle continues to outperform larger fast-food rivals Yum! Brands (NYSE: YUM  ) and McDonald's (NYSE: MCD  ) in the U.S.

Blowing away rivals
Same-store sales growth for Chipotle was phenomenal, up 13.4% over the first quarter of 2013, an acceleration over the impressive 9% comps number in the prior quarter. That helped drive overall revenue for the chain up 24.4%, to $904 million.

Both Yum! and McDonald's have seen same-stores sales growth in the U.S. come to a halt. Yum!'s numbers for 2013 were flat with 2012. At Taco Bell specifically, same-store sales growth crept along at 1% in the quarter reported in February, down from about 5% a year earlier. Taco Bell generates two-thirds of Yum!'s U.S. profits., so slowing growth there can really hurt the company's efforts in the U.S.

McDonald's has been experiencing shrinking same-store sales in the U.S., with the company reporting slower sales for the third straight month in March. Bloomberg attributed the slowdown to both fierce competition in fast food, and to "declining consumer sentiment."

The market message
Chipotle, meanwhile, has been able to rise above that fierce competition. Credit that to rising consumer sentiment in its brand and the decline of sentiment in brands like McDonald's. The company's marketing efforts have focused around building awareness about food quality and sourcing.

"Ultimately, it's our belief that the more people know about their food and how it was raised and where it comes from, the more likely they will be to eat at Chipotle," Chairman and Co-CEO Steve Ells said.

It's trying to win customers over with the idea that they should be eating food that's healthful, natural, sourced from quality ingredients that are not from factory farms, and prepared right in front of you. It's fast food as anti-fast food.

More pricing power than it needs
The message is resonating, and it's a big reason why Chipotle is in a good position to raise prices. Food costs – especially those for beef, avocados, and cheese – are rising faster than expected. They now make up 34.5% of Chipotle's costs, and if the chain does nothing, that will rise to 36% later this year, management says. So, a price hike is prudent to offset those increasing costs.

Chipotle plans a hike in the mid-single digits. So, somewhere around $0.50 on your average $10 check. It believes it could enact an even bigger price hike, but as CFO Jack Hartung says, the company would like to keep some of its pricing power "in the bank."

The reason why management believes it has even more pricing power than it needs has everything to do with the "Food With Integrity" message resonating with customers. If diners truly believe they are getting both a more healthful and better-tasting meal at Chipotle than other available options, those extra two quarters at the register won't seem like much more to pay.

The Foolish bottom line
Rising food prices are a concern, and we can't know for sure how Chipotle's customers will respond to the first price hike in three years until they respond. But if there's one restaurant that's positioned itself well for a price hike in 2014, it's Chipotle. Investors may want to use the market's knee-jerk reaction as an opportunity to open or add to a position in the company.

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