Will Rising Prices Destroy the Momentum at Chipotle?

Fast-casual restaurant chain Chipotle finally made the decision to raise menu prices recently, believing that the move won't deter customers from flocking to its stores. Will the price hike change the story for investors?

Jun 13, 2014 at 5:30PM

Fast-casual restaurant chain Chipotle Mexican Grill's (NYSE:CMG) business has remained hot in FY 2014, despite weather-related slowdowns that have cooled the results of competitors like Panera Bread (NASDAQ:PNRA). In its latest financial update, Chipotle reported a strong top-line gain, helped by a double-digit comparable-store sales gain and a continued expansion of its national store base.

On the downside, though, Chipotle has been negatively affected by rising commodity costs, especially for beef and avocados, a trend that caused management to make the decision to raise menu prices, its first increase in three years. However, with a customer base that anecdotally doesn't seem to be too price-sensitive, it is unclear what the impact will be on the company's bottom line. So, after raising prices, is Chipotle's investment story still intact?

What's the value?
Chipotle has been one of the runaway success stories of the restaurant sector, building a network of more than 1,600 stores over the past 20-plus years. Much of the company's success has been due to its focus on high-quality ingredients, part of its Food With Integrity mission, which has allowed it to acquire a loyal and growing customer base. More importantly, its customer base has been generally less price-focused than customers at traditional fast-food chains, creating a highly profitable business model that has fueled Chipotle's fast growth.

In its latest fiscal year, it was more of the same for Chipotle, evidenced by a 17.7% top-line gain that was a function of higher comparable-store sales and a double-digit expansion of its overall store base. While the company was pressured by the aforementioned rise in commodity costs, it used productivity gains at the store level to maintain a healthy operating margin above 16%. The net result for Chipotle was strong cash flow generation, further padding its cash-rich balance sheet and providing funds for growth opportunities, including a nascent move into the catering segment.

A fast-casual slowdown
Of course, the question for investors is whether the company can continue its heady growth trajectory, given rising menu prices and a recent slowdown at some of its competitors, including fellow fast-casual leader Panera. Like Chipotle, Panera has acquired a large and loyal customer base, with roughly 15 million MyPanera card members at last count, by offering better quality food than the traditional fast-food chains, highlighted by antibiotic-free chicken and whole grain breads. Consequently, Panera has enjoyed more than a decade of steady growth, reporting its 14th straight year of positive comparable-store sales increases in FY 2013.

Unfortunately, that run looks like it might come to an end in FY 2014 after the company posted a 0.1% comp gain in its latest fiscal quarter, a data point that management blamed mostly on weather factors. Worse, Panera continues to exhibit a negative trend in customer volumes, as opposed to the positive trend at Chipotle, which has limited its pricing power, leading to a decline in operating profitability. The net result for Panera has been lower operating cash flow, hurting its ability to both invest in new store growth and an overhaul of its existing stores through its recently announced Panera 2.0 initiative.

Also slowing down in the current environment has been Noodles & Company (NASDAQ:NDLS), a Chipotle lookalike that similarly banks on the use of natural/organic ingredients and an open kitchen layout. In its most recent fiscal quarter, Noodles & Company ended a string of 18 consecutive quarters of positive comparable-store sales growth, reporting a 1.6% decline. Combined with rising commodity costs, the result was a decline in operating profitability for the company, leading to near-term weakness for its stock price.

The bottom line
Chipotle seems to be a cut above the rest of the fast-casual restaurant field, showing no signs of the business slowdown that has hit competitors like Panera and Noodles & Company, which has been reflected in their negative year-to-date stock price performances. That being said, with a P/E multiple of roughly 53, Chipotle's shares are not cheap and are susceptible to downside risk in the event that the company falls prey to the same slowdown trends affecting its competitors. As such, investors might want to wait for lower levels to materialize prior to buying into this segment leader.

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Robert Hanley owns shares of Panera Bread. The Motley Fool recommends Chipotle Mexican Grill and Panera Bread. The Motley Fool owns shares of Chipotle Mexican Grill and Panera Bread. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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