Chipotle Just Had an Awesome Quarter, But I'm Still Not Buying the Stock

Many restaurants are struggling with the effects of the coronavirus, but Chipotle's (CMG 0.53%) business is doing better than most. Its easy-to-use digital ordering app and delivery partnerships have enabled the burrito maker to actually increase comparable restaurant sales and grow overall revenue year over year in its most recent quarter. But the stock is trading close to all-time highs, despite numerous challenges still ahead. Let's dive into the details of its most recent quarterly results and why I'm buying burritos instead of the stock.

More burritos sold in more places

Looking at the top-line numbers for this brick-and-mortar establishment, you would be hard-pressed to guess that we are in the middle of a pandemic. The top line grew 14.1% year over year for its third quarter ending Sept. 30, 2020, on the strength of price increases and solid comparable restaurant sales of 8.3%. Its digital sales were a highlight, coming close to 50% of its revenue and tripling from its level from a year ago. It added a net 41 restaurants to bring its total to 2,710, but costs due to the coronavirus threw a wrench in store-level margins and the bottom line.

Restaurant operating margins dropped to 19.5%, a decline of 1.3 percentage points from the year-ago, non-coronavirus-affected quarter. Even though digital ordering is a benefit to labor costs, employees are instructed to stay home if they are sick, driving additional expense for sick pay and the cost for the person who has to cover the shift. Increased marketing spend and subsidizing delivery costs also affected margins. As a result, net income decreased from 7% of revenue in Q3 2019 to 5% of revenue this quarter. 

But there were some further bright spots. The limited time carne asada menu option increased demand, Chipotlanes (the company's drive-through, digital-order-only stores) have been positive for margins, and all but 10 restaurants were open during the quarter. Additionally, management expressed confidence in the earnings call to reach their long-term goal to more than double the number of restaurants to 6,000. This is all great news, but Chipotle's financials haven't completely recovered to where they were before the food safety issues five years ago. 

Image source: Getty Images.

Looking back to a different time

In Q3 five years ago, digital orders weren't even a mention on the earnings call, and stores were experiencing a record level of sales with lines frequently out the door. But that was one quarter before the company's E.coli and norovirus events, and things look very different from today.

Note: *the latest average restaurant sales don't include delivery orders. YOY= year-over-year. Data from company earnings reports. Table and calculations by author.

Over the past five years, revenue has grown 30%, but it has been largely driven by its 40% increase in its store base. With top-line growth and comparable same-store sales improved from the previous mark, things look to be improving on the sales side. But average store sales volume is still below its peak five years later. Even with a significant portion of sales coming from margin-benefiting digital ordering, restaurant-level margins, net income, and net income as a percentage of revenue are all much lower today.

Yet, the stock has doubled over the past five years. Let's look at why.

What about the stock price?

Most of the gains in the stock have come from the lows of 2018, as the company was putting its food safety events behind it and Brian Niccol took over as CEO in February 2018.

Five-year history of Chipotle stock price and price-to-earnings (P/E) ratio through October 26, 2020. CMG data by YCharts

Niccol has been a refreshing change in leadership. He accelerated Chipotle's digital efforts, put in a new management team, and gave investors confidence with his back-to-basics approach. This optimism has extended the P/E ratio to a lofty triple-digit mark of 160, a four-fold increase from what it was five years ago and carrying it significantly higher than its peers. I appreciate the results-focused approach that the new management team has instilled, but there's a ton of optimism priced in the stock that I don't think is warranted.

Margins will remain under pressure throughout the coronavirus and until a larger base of Chipotlane stores can be opened (it has 128 today). Revenue growth has been strong, as its stores have remained open and its digital ordering made contactless pickup and delivery convenient for consumers, but demand could wane if the recession is extended due to a stubborn coronavirus situation. Additionally, don't count on store growth to make a big difference anytime soon. Doubling the store base will take another 13 years at its aspirational rate of 200 new stores per year.

The bottom line for investors

With a premium valuation, an uncertain economic environment, and margin pressures due to a coronavirus that isn't going anywhere anytime soon, I wouldn't buy the stock here. Even if by this time next year, the coronavirus is on its way out due to a successful vaccine, there are lots of things that still have to go right for this burrito maker for its stock to have the same kind of gains in the next five years that it's had over the last five. 

I'm happy to watch from the sidelines as a customer rather than a shareholder of this consumer discretionary stock.

Note: My ownership of Chipotle stock shown in the disclosure is through a UTMA account for my son. I don't personally hold shares.