Chipotle Mexican Grill (CMG 0.40%) is still struggling in the aftermath of a late-2015 E. coli outbreak that spiraled into a broader food safety crisis. Comparable restaurant sales plunged 20.4% in 2016, nearly wiping out the company's profit for the year. (Earnings per share for the full year fell to $0.77 from $15.10 a year earlier.)
However, the fast casual giant is starting to get back on track. In a sign that it may have reached a turning point, Chipotle recently raised its prices at about 20% of its restaurants. If customer traffic continues to rise despite these price increases, it would be a strong sign that Chipotle will be able to make a full recovery in the coming years.
Chipotle is healing
While Chipotle Mexican Grill still has a lot of work ahead of it, the company is clearly on an upward trajectory. First, Chipotle's reputation is starting to improve. This has allowed it to go back on offense in its marketing, highlighting the fact that it is now the only national restaurant brand that doesn't use any added colors, flavors, or preservatives in its food.
Second, the company is focusing on the basics in its restaurants in order to improve customer service and increase throughput. Enhancements to its mobile app should also drive faster sales growth going forward.
Chipotle is focused on keeping operations smooth this year. Image source: Chipotle Mexican Grill.
As a result, customers are starting to return to Chipotle. Comp sales began growing again in December, and this recovery should continue in 2017. Chipotle has forecast a high single-digit comp sales increase for the full year.
There was fairly wide regional variation in Chipotle's comp sales performance last year. For example, West Coast markets significantly lagged the rest of the company. Yet there is at least some evidence that these regional differences are starting to fade. This could help Chipotle's recovery gain momentum over time.
A price increase -- in some markets
On Chipotle's earnings call in early February, company executives said that they might raise prices in some markets this year in order to offset cost increases. The biggest cost headwind has been payroll, as many states and cities are raising their minimum wages.
That said, Chipotle's management is being mindful of the regional differences in its sales performance. On the earnings call, CFO Jack Hartung said the company would look to raise prices in markets that have recovered the best.
Accordingly, Chipotle implemented a 5% price increase in about 20% of its restaurants earlier this month. "The increase is our first in about three years, and was implemented to help offset labor and food inflation," a company spokesperson told Bloomberg. (To be exact, it's the first price increase touching the whole menu in three years -- Chipotle raised the prices of its steak and barbacoa entrees in mid-2015 to cope with a surge in beef prices.)
Chipotle indicated that it doesn't plan to implement any other price increases in the near future. This suggests that it is sticking with its strategy of keeping prices flat in markets where cost inflation is less of a problem and in markets with weaker sales trends.
This would be great for investors if it works
In the past, Chipotle has had no trouble implementing price increases of this magnitude. But it's on much shakier ground than it was a few years ago. Hopefully, the decision to limit price increases to better-performing markets will ensure that the change doesn't undermine Chipotle's sales recovery -- but there are no guarantees.
Assuming that customers accept the price increases, this change should boost Chipotle's pre-tax margin by close to 1 percentage point and increase its earnings per share by about $0.80 on an annual basis. That would certainly represent a meaningful improvement.
Chipotle's management may comment about whether they are seeing any pushback on the price increases during the company's earnings call next week. I will be listening closely to see what they say. If customers aren't blinking an eye at a 5% price increase, it's a strong sign that the public is ready to forgive Chipotle for its previous food safety lapses.
