A random regulatory filing has convinced the media that Chipotle Mexican Grill (NYSE:CMG) has no idea what it's doing.
At the beginning of July, the burrito chain responded to a request from the Securities & Exchange Commission to clarify two points in a recent quarterly report. The SEC wanted to know how Chipotle's recent promotional campaigns have impacted its revenue.
(For those of you who haven't followed Chipotle's saga, it's given away a gazillion or so coupons for free burritos since the beginning of the year to lure back customers who had been scared away by food borne-illness outbreaks at the chain last year.)
Here's how the SEC phrased the request in its letter to Chipotle:
In light of the significant promotional activities begun in the first quarter of 2016, such as coupons issued for free products, please revise your revenue recognition policy to describe your accounting for such promotions and sales incentives. Also, to the extent that amounts recognized for such incentives are material, please disclose the amount... Your discussion should also be revised to discuss the extent of the contribution of these incentives/promotions to the change in revenue and operating income.
Fair enough, right? If Chipotle is dropping coupons for free burritos out of helicopters over Justin Bieber concerts, its shareholders have a right to know how that impacts the top line.
But here's the thing -- and this is why the media seems to think Chipotle's executives are incompetent -- the chain claims to not know the answer to this. Here's a selection from its response to the SEC:
[G]iven the unusual sales trends resulting from the food borne-illness incidents, we were unable to calculate or accurately estimate any indirect impact that promotional activity had on revenue.
This led an author at Bloomberg to claim that Chipotle "doesn't even know if those free burritos are working." A piece from Business Insider followed this up by opining that Chipotle "might be wasting millions of dollars on free food."
Hyperbolic headlines are a great way to get clicks. In this case, however, it's absurd to suggest that Chipotle has no idea what it's doing simply because it told the SEC that it can't calculate the impact that these promotions have on its top line.
As Chipotle explained elsewhere in the letter, it does "not recognize any revenue on free food coupons" that are redeemed by customers. The reason Chipotle didn't disclose an impact on its revenue, then, is because there wasn't much of an impact in the first place.
This isn't to say that the coupons had no effect whatsoever on Chipotle's top line. Some of the customers that redeemed free-burrito coupons probably got drinks. Or chips. Or extra sides of lettuce for their pet rabbits.
Any of these transactions would result in revenue. But because transactions like these are small, typically ancillary to the purchase of an entree, the overall impact very well may be immaterial, relieving Chipotle of the obligation to disclose the information.
This is why Chipotle said in its response to the SEC that it would provide in future filings "any quantifiable, material impacts of promotional offers on changes in revenue."
Chipotle also makes a valid point that the unusual sales trends it's experiencing right now would complicate efforts to isolate the impact of promotional changes. This is particularly true when you consider, as we just covered, how small the impact would likely be.
There are many other significant things that are causing its revenue and earnings to fluctuate more than usual right now, from opening new stores to dramatically lower same-store sales. The data, in other words, is very noisy.
If Chipotle operated in the sterile confines of a laboratory, where it had complete control over its environment, then the media would have a legitimate reason to question the competence of the chain's executives for not knowing the impact from its recent promotional campaigns on the top line. But it doesn't.
In short, while Chipotle's investors have been on a wild ride over the past year, I don't believe this latest development should affect your investment thesis in the burrito chain.