Chipotle Mexican Grill's (NYSE:CMG) post-pandemic recovery continued to gain traction in the first few months of 2021. Indeed, the fast-casual pioneer set new records for quarterly revenue and adjusted earnings per share last quarter.
Revenue and earnings growth is poised to accelerate further in the second quarter, thanks to easy year-over-year comparisons and the continued reopening of the U.S. economy. However, Chipotle's earnings growth is likely to moderate within a few years. That makes Chipotle stock -- which has rallied 88% over the past year -- look overpriced at 47 times the company's projected 2022 earnings.
Revenue and earnings growth accelerate
Chipotle's business started to regain its momentum in the second half of 2020, despite the ongoing pandemic. In the fourth quarter, comparable sales rose 5.7% and adjusted earnings per share increased 22% year over year.
This momentum accelerated last quarter. On Wednesday afternoon, Chipotle reported that Q1 revenue grew more than 23% to $1.7 billion, driven by a 17.2% comp sales gain. Digital sales more than doubled year over year, representing about half of the chain's sales mix. Order pickup -- Chipotle's most profitable transaction type -- accounted for slightly more than half of those digital orders.
Even more impressively, Chipotle's adjusted earnings per share surged 74% year over year, reaching a new quarterly record of $5.36. This easily beat the average analyst estimate of $4.89.
Growth is poised to accelerate in the second quarter. Chipotle's comparable sales grew just 3.3% in the first quarter of 2020 as the pandemic started to weigh on sales, but the company faces an even easier year-over-year comparison this quarter, after comp sales plunged 9.8% in last year's second quarter. As a result, management expects Q2 comp sales to jump as much as 30%.
Long-term and temporary margin tailwinds
Chipotle's impressive earnings growth last quarter was fueled by a 4.7-percentage-point increase in its restaurant-level operating margin. Growth in sales per restaurant is providing a significant tailwind for restaurant-level operating margin.
Trailing-12-month sales per restaurant will likely reach $2.4 million by the end of this quarter. That would be just shy of the historic high of $2.5 million reached in 2015 and well above the nadir of $1.9 million recorded in 2016 (when food safety issues crushed Chipotle's sales). Menu price increases and the growth of digital ordering -- which enables more efficient food preparation -- should allow Chipotle to boost sales per restaurant well beyond $2.5 million over the next several years, unlocking further margin gains.
That said, Chipotle also benefited from unusually low food costs last quarter. Food, beverage, and packaging costs consistently accounted for between 33% and 35% of Chipotle's revenue between 2013 and 2019, before falling to 32.3% last year. In Q1 2021, Chipotle spent just 30% of its revenue on food, beverage, and packaging costs, down from 32.8% in Q1 2020.
This reduction in food costs powered the majority of the company's Q1 margin expansion. However, the margin structure achieved last quarter isn't sustainable. Indeed, food costs are already on track to normalize in the second quarter. Chipotle still has plenty of room for margin growth, but future gains will be harder to come by, leading to slower earnings growth (all else equal).
A realistic view of Chipotle stock
When Chipotle was firing on all cylinders prior to its late-2015 meltdown, it was able to generate high-teens operating margins, peaking at over 18%. However, Chipotle's operating margin is unlikely to return to that level, due to rising labor costs, higher marketing and technology investments, and costs associated with delivery. (In recent years, its operating margin has been stuck in single-digit territory.)
In a relatively optimistic scenario, Chipotle might grow to 5,000 restaurants globally by the end of the current decade (up from 2,803 as of March 31), with average sales per restaurant of $3.3 million and an operating margin of 16%. That would imply annual sales of $16.5 billion and net income of around $2 billion.
Chipotle stock's diluted market cap is approximately $42 billion. In other words, the stock already trades for 21 times its potential 2030 earnings -- if the business performs well between now and then. Moreover, with 5,000 restaurants, Chipotle could be close to saturating its core markets by then. (For years, the company has estimated its long-term growth opportunity as at least 6,000 restaurants.)
Of course, Chipotle could grow even faster than I expect. But it's also quite possible that the business will underperform my projections. At its current price, Chipotle stock doesn't seem to offer enough long-term upside to justify an investment.