Chipotle Mexican Grill (CMG 1.07%) seemingly had no issue navigating the coronavirus pandemic, as it leaned on its digital capabilities to find ways to serve hungry customers, boosting sales and profit along the way. This positive performance is evident in the stock price, which is up 73% over the past three years, despite falling 21% in 2022.
But what's on the horizon for this Tex-Mex chain? Here are the bear and bull cases for this seemingly unstoppable restaurant stock.
Lots of reasons to be optimistic
As many businesses struggled with tough year-over-year comparisons and macroeconomic headwinds like high inflation and interest rates, Chipotle's growth remains superb. The business increased revenue 13.7% in the third quarter, with diluted earnings per share rising 28.1%. Same-store sales were up 7.6%, proving that existing locations are also growing.
Chipotle has continued to lean heavily on its digital foundation. It launched a rewards program in March 2019 that now has 30 million members. To demonstrate just how impressive this figure is, Starbucks, a company that many consider to have the most robust loyalty program, currently has 28.7 million rewards members in the U.S.
Chipotle's ongoing goal is to find ways to boost accessibility and convenience for its customers, letting them order their favorite dishes in more ways. The company expects to open 255 to 285 new restaurants in 2023, with 80% having a drive-thru attached. As more customers use digital ordering channels, Chipotle will be able to drive higher sales volume per store, leveraging its fixed costs and bolstering profitability.
As for the macroeconomic environment, Chipotle certainly hasn't been immune from rising costs across its business, particularly for things like dairy products, packaging, and tortillas. This has the potential to squeeze margins for its restaurants. Chipotle is in such a powerful competitive position that it has been able to successfully raise menu prices multiple times over the past year and a half. In fact, margins improved in the latest quarter.
"We know our value proposition remains strong, and we experienced minimal resistance to our price increase in the quarter," CEO Brian Niccol said on the third-quarter earnings call. It's hard not to like a business that is barely showing any signs of weakness right now.
Measuring headwinds
While Chipotle has shown it can continue posting solid growth amid a softer economy, it's hard not to imagine a scenario where the company isn't hurt if the U.S. enters a full-blown recession this year.
In fact, transaction counts declined 1% in the most recent quarter, according to Niccol. Management will closely follow this trend, which has been spurred by lower-income consumers frequenting Chipotle less often.
Research from the U.K. Institute for Fiscal Studies found that consumers will focus more on grocery shopping and eating at home when times get tough. So such changes in consumer behavior will certainly affect Chipotle's revenue in the near term.
I mentioned earlier how the chain has successfully raised menu prices multiple times, with seemingly no impact on sales. Management doesn't hesitate to stress how great the company's value proposition is for customers, which has made price hikes an easy strategy.
But there's always a risk that it presses this advantage too much and alienates customers in the process. If input costs continue going up, the leadership team will be faced with tougher decisions about how to balance profitability with growth.
Perhaps the most important bear argument for Chipotle is the stock's current valuation. As of this writing, shares are trading at a price-to-earnings ratio of 48. That's substantially more expensive than its restaurant peers. And it leaves no margin of safety for investors looking to achieve satisfactory returns over the next few years, no matter how much growth potential the company has.
Chipotle's trailing-five-year stock returns have been nothing short of spectacular, but shareholders must assess both the positives and negatives.
