On Oct. 21, Chipotle Mexican Grill (CMG -0.24%) reported third-quarter adjusted earnings per share of $3.76 (above the consensus estimate of $3.47) on revenue of $1.6 billion (in line with the consensus estimate of $1.59 billion). Comparable-store sales increased by 8.3%, with August having the highest revenue in the quarter. Digital sales were particularly strong, up 202.5% year over year, as consumers flocked to its delivery offerings and drive-thru digital order pick-up lanes, known as Chipotlanes. From mid-September, comparable restaurant sales increased in the mid-single digits, and this growth continued into October.
On the surface, a solid earnings report for the fast-casual restaurant chain. But does the company hold up as well when looking closer at the details in the report? Here are three takeaways from the quarter.
1. Digital revenue was very strong for Chipotle in Q3
Chipotle's digital revenue in the third quarter carried the day, increasing 202.5% year over year and comprising 48.8% of total revenue. Delivery revenue was about half of all the digital revenue, driven by partnerships with third parties. The other half of digital revenue was made up of order-ahead and pickup orders as consumers embraced the changes forced by COVID-19.
Digital revenue benefited as consumer behavior shifted as COVID-19 restricted dine-in options and caused some people to be more cautious about eating out. Moreover, increased remote work and delivery partnerships with Grubhub and Uber's Uber Eats also helped boost the quick-service chain's digital platform.
Digital will continue to be an important part of Chipotle's future growth. CEO Brian Niccol noted on the Q3 earnings call: "The stickiness of digital is a key factor in allowing us to deliver strong results, and we'll continue to invest in making the digital experience as easy and frictionless as possible as illustrated by the recent launch of our group ordering feature on the Chipotle app." The company sees digital sales being higher than $2.5 billion in 2020 (more than double 2019's level) if the current momentum continues.
2. Expenses increased, margins fell during the quarter
Restaurant-level operating margin fell to 19.5% in Q3 from 20.8% a year ago. Labor costs increased, driven by higher delivery expenses, and operational costs were up as well, partially due to elevated beef prices. Digital improvements at restaurants and price increases on the menu helped to offset some of these higher costs.
There were also higher expenses from COVID-19, mainly from higher labor expenses as the company paid employees to stay home if they believed they were exposed to the coronavirus. However, Chipotle expects that the higher costs related to COVID-19 will ease after the fourth quarter. "Looking beyond Q4, we expect COVID-related direct and indirect costs to ease over time, and we have a number of plans in place to ensure we're able to deliver our full margin potential," CFO John Hartung said on the Q3 earnings call.
3. Chipotle is well-positioned for future growth
Future revenue growth looks good as management says it's prepared for the near-term uncertainty around COVID-19. The chain is well equipped to handle potential increases in COVID-19 cases, having previously invested in air filtration systems, sanitizers in restaurants, and wellness protocols. These updates, combined with strong digital systems enabling more takeout and delivery revenue, will help Chipotle thrive through any resurgences of the virus.
Management plans to go forward with additional development of its highly successful Chipotlanes as part of its new restaurant openings. During the third quarter, 41 net new restaurants were opened, including 26 with Chipotlanes. Revenue of the 17 Chipotlanes in Chipotle's comp base (opened pre-COVID-19) was more than 10% higher compared to non-Chipotlane restaurants during the same period. Comps for the more recently opened Chipotlane stores performed 25% better. This year's restaurant openings will include about 60% with Chipotlanes, with a longer-term goal of 70%.
While the restaurant company is planning to open slightly more stores in Q4 than in Q3, Chipotle management is not giving guidance for new restaurant openings in 2021 given current uncertainties. Hartung explained:
"Our development team has built a very robust new store inventory, which under normal circumstances would be to opening around 200 restaurants next year. As the permitting process and groundbreaks become more certain in the coming months, we'll provide as much visibility as we can around expected openings by quarter and for all of 2021. Longer term, we've remained confident in our ability to more than double total number of Chipotle restaurants in the U.S."
Overall, Chipotle appears to be well-positioned going into the final quarter of the year. Its menu offerings hit all the right notes in the current environment, where consumers favor quick-service takeout options that allow for social distancing and provide value. Management appears to have a plan in place to grow revenue and justify the price premium the stock currently trades under and investors still have time to benefit from additional growth going forward.