Chipotle (CMG 0.64%) delivered its first-quarter update on April 26, revealing both rising sales and profits. The company has responded to increased costs for ingredients and labor by exercising its pricing power and raising what it charges for its dishes.
Customers remained willing to pay those higher prices, likely because they have observed prices increasing for a wide range of products and services. Therefore, Chipotle, even after its price increases, is not seen as providing a lower relative value.
Inflation is hurting restaurant profit margins
In the quarter, Chipotle's comparable-store sales increased by 9% year over year. Its overall sales increased by 16% as Chipotle has been busy opening new locations throughout the U.S. Further fueling the revenue growth has been the return of in-restaurant diners now that the pandemic-related risks have declined.
With COVID-19 vaccines and treatments readily available, folks feel more comfortable resuming their pre-pandemic routines. As a result, in-restaurant sales increased by 33.1% at Chipotle in Q1. Notably, however, digital sales remained a robust 41.9% of sales. People are not replacing digital takeout orders with in-person visits. Instead, they're doing both. That pattern undoubtedly contributed to Chipotle's sales bounce from $5.6 billion in 2019 to $7.5 billion in 2021.
That has not been achieved without challenges. Chipotle is experiencing rising costs in nearly all parts of its business. To attract and retain the employees required to meet increasing customer demand, Chipotle instituted a 15% average pay raise.
Moreover, food and packaging prices have risen by double-digit percentages. Those higher costs are eating into Chipotle's restaurant-level operating profit margin, which fell by 160 basis points in Q1. The chain has implemented several rounds of menu price increases to offset these higher expenses, with the latest, a 4% increase, coming at the end of the quarter.
Management says it is seeing input costs stabilize, and customers continued to visit Chipotle despite the price increases. Further, despite decreasing profit margins, diluted earnings per share increased by 25.6% to $5.59.
The market is not impressed
Despite the company's solid performance amid a challenging economic environment, the market has not been impressed. Chipotle's stock price is down 18% year to date. Its food, beverage, and packaging costs rose 31% year over year in Q1, while its labor costs increased by 26.3%.
Investors are concerned that costs will continue growing and Chipotle will exhaust its ability to pass along those higher prices to customers with impunity. If that occurs, the company could have to accept lower profit margins for quite some time. So until inflationary pressure stabilizes, Chipotle's stock may remain in the penalty box.