In November, Goldman Sachs predicted that the S&P 500 would end 2023 right about where it started. The thinking behind this flat forecast is that corporate revenue will rise 4%, but because of inflationary pressures, earnings growth will be nonexistent. With valuation multiples staying the same, stock returns won't impress.
That being said, while many other businesses contend with slower growth and pressured margins, Chipotle Mexican Grill (CMG 0.40%) continues to prove its worth. In fact, its profitability is surging. Does this mean you should buy the stock? Let's take a closer look.
A tasty bottom line
For the fourth quarter of 2022, which ended on Dec. 31, Chipotle posted revenue of $2.2 billion, good for an 11.2% year-over-year increase. Same-store sales, a key metric for any retail-based business, rose 5.6% from Q4 2021. While these figures represented a slowdown from previous quarters, they are no doubt healthy gains given the difficult macro environment. What's more, the company opened 236 new stores throughout 2022, bringing the total to 3,187 today.
The top-line growth was respectable, but what really stood out was Chipotle's profitability. The company's operating margin in Q4 of 13.6% represented a huge gain from the prior-year period's 8.1%. This is a clear sign that macro headwinds, particularly elevated inflation, aren't really proving to be a challenge for the company.
Since this is a restaurant business, Chipotle is exposed to unpredictable food prices. On the latest earnings call, management specifically called out higher costs for dairy products and tortillas as a headwind in the fourth quarter. And in the current quarter, they expect higher prices for queso, salsa, spices, and oil to have an impact.
However, Chipotle has proved that it benefits from one of the most sought-after characteristics that any business can have -- pricing power. The company has raised its prices multiple times over the past couple of years. And in the fourth quarter, menu prices were 13.5% higher than they were a year ago.
"We really have not seen any meaningful resistance to our pricing, especially as it relates to our in-store experience," CEO Brian Niccol mentioned on the call with analysts. And based purely on anecdotal evidence, it's hard to find a better value proposition than Chipotle in terms of quality and quantity of food, despite higher prices for customers.
Management doesn't provide margin guidance. And to be fair, Chipotle's fourth-quarter operating margin did show a slight decline from the prior two quarters. But investors should remain optimistic because of the positive year-over-year trends. Even more impressive are the long-term improvements. Five years ago, in the 2017 fourth quarter, Chipotle's operating margin was just 5.7%.
Chipotle has benefited from increasing its annual unit volume (AUV) over time, now at $2.8 million. The name of the game is to push this number higher, while benefiting from leveraging fixed costs.
"We have a long growth runway ahead with the ability to more than double our restaurant count, grow AUVs beyond $3 million, and expand margins," Niccol said. That means profitability is likely to expand even more in the years ahead.
The stock is priced for perfection
Even though Chipotle is in a strong position right now, opening new stores, growing revenue, and expanding margins, the stock doesn't look cheap. Shares have soared 379% over the past five years, and they now trade at a price-to-earnings multiple of more than 47. This valuation has come down over the past couple of years, but it's still expensive, even when you consider Chipotle's growth prospects.
Investors who are OK with the expensive valuation might still want to consider the stock to protect their portfolios in case of a recession. That's because Chipotle has shown how resilient of a business it really is, based on its healthy growth and strong margins. In this type of economic environment, these positive characteristics definitely hold value.
