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Chipotle and the Cruel Math of Big Numbers

By Rick Munarriz – Oct 27, 2016 at 10:34AM

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The struggling burrito roller has another rough quarter, giving it a longer road back.

Image source: Chipotle.

Quarterly reports have become scary affairs for Chipotle Mexican Grill (CMG 2.16%) investors. Shares of the restaurant operator plunged 9% yesterday -- hitting a three-year low in the process -- after Chipotle offered up another period of cascading sales, plunging comps, and tumbling profitability. 

It was an ugly report out of a company where investors should be used to bad news by now. The bar is set low, but Chipotle thinks the game is limbo instead of a pole vault. It posted its first loss as a public company during this year's first quarter, and it nearly duplicated the feat this time around with earnings plummeting 94% since the prior year's third quarter showing. There were some one-item items weighing on the report, but even if you back out a ShopHouse impairment charge and the deferral of Chiptopia-based revenue, you still find net income plunging by 83%.

Comparable-restaurant sales fell 21.9%, a shocking number when you consider that the last of the brand-crippling food-borne illness outbreaks happened nearly a year ago. Hungry burrito seekers have not forgiven or forgotten. 

Big numbers cut both ways

The average Chipotle has seen its sales shaved by more than a fifth over the past year, but this doesn't mean that it's attracting 21.9% fewer customers. The actual transaction count per store has declined by 15.2%. That's still brutal, but the difference between the two numbers is the handiwork of folks spending less now. Chipotle's been giving away a lot of stuff to woo customers, and between the Chiptopia rewards program that handed out free entrees to frequent diners and the September promos that involved free kid meals on Sundays and free fountain drinks to high school and college students, the markdowns at the register leave a dent. Eyeing the bottom line also reveals how devastating the serial discounts can be to an eatery's margins. 

This is now the fourth consecutive quarter of negative comps. Chipotle expects that streak to stretch to five periods, targeting a decline during the holiday quarter in the low single digits. The comparisons will get easier from here. Chipotle's eyeing an increase in the high single digits for all of 2017. That may set some minds at ease, but this doesn't mean that we will be back to where we were when things started to fall apart in late 2015. This is where the same big numbers that dominated Chipotle's rise in becoming a market darling come back to sting the baron of burritos.

Big numbers matter. How strong would comps have to be in the third quarter of 2017 to get back to where it was in the third quarter of 2015, the last of its periods with positive comps? It may be instinctive to say 21.9% -- the amount of the slide in this latest quarter -- but that would not be correct.

Comps fell 21.9% during this year's third quarter, and that means that the average restaurant is selling 78.1% as much as it was a year earlier. If comps were to surge 21.9% a year from now, that would be off the new normal where the average eatery is ringing up more than a fifth less in sales than it was before. Multiply 78.1 by 1.219 and you're at 95.2%, or what can also be expressed as a decline of 4.8% over two years. 

Chipotle comps have fallen 24.9% through the first nine months of the year. It would have to take a 33.2% surge in comps to get back to zero. Suddenly applauding Chipotle for the positive comps in the high single digits that it's targeting for 2017 doesn't seem so impressive. It's a step in the right direction, but still a small step.  

Big numbers used to be a tailwind for Chipotle. Few may recall that Chipotle rattled off five straight quarters of double-digit increases in comps through all of 2014 and the first quarter of 2015. The chain's biggest menu price hike in three years was the catalyst at the time. Now we're seeing big numbers as a headwind as Chipotle begins what will be a long road back to where it used to be. Chipotle will get there, but it's going to require the kind of patience that growth stock investors often have a difficult time mastering.

Rick Munarriz has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Chipotle Mexican Grill. 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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