The last time we heard from Chipotle Mexican Grill (NYSE:CMG) co-CEOs Steve Ells and Monty Moran, the market panicked. The burrito roller's stock plunged 22% the following day and another 12% in the days following the earnings report.
What disaster befell the upstart restaurant chain? Simply a mild top-line miss. The market had expected revenue of $706 million, but Chipotle only came up with $690 million. Same-store sales of 8% also disappointed analysts, who had been looking for a 10% gain in comps. Despite the slowdown in sales growth, its earnings still crushed estimates, growing a whopping 61%.
Investors who held on are surely hoping for some redemption when Chipotle reports third-quarter earnings after hours on Thursday. Let's take a look at a few of the major factors that could affect earnings.
The biggest issue in the domestic food industry in the third quarter was the drought that damaged crops in much of the Midwest and other parts of the country. At the retail level, consumer prices only grew by about 2% over a year ago during the quarter, largely in line with overall inflation. Corn futures, meanwhile, have gone up about 30% since their bottom in the spring, and while corn prices affect food costs for everything from soft drinks to livestock, these price increases will hit different food products at different times and the extent of their effect on Chipotle's end product is unclear. The USDA has projected 2.5% to 3.5% inflation in food prices for 2012, so based on that forecast and the modest rise in the CPI, it would seem that any effects from the drought would be minor, likely a percentage point or two.
For a comparison, domestic food costs at Yum! Brands (NYSE:YUM), which reported third-quarter earnings last week, actually went down 2 percentage points. Chipotle may be affected in ways that Yum! was not, however, since it uses organic and local food when possible.
The improving economy
Countering the rising food costs from the bad weather is the improving economic picture around the country. September retail sales jumped 5.4% from a year ago, and sales at quick-service restaurants climbed 4.3% in July and 6.5% in August. Considering Chipotle management had only projected mid-single-digit same-store sales in its last report, those numbers look promising. The company generally trounces the industry average, so I would expect it to clear the mid-single digits with relative ease.
Consumer confidence numbers also recently reached a level not seen since 2007, so I expect the beefed-up retail spending to continue into the fourth quarter. Seasonally, July and August are also the strongest months in the quick-service restaurant sector.
The Einhorn effect
While not a direct influence on Chipotle's operations, David Einhorn's recent remarks deserve some consideration nonetheless. By September, Chipotle's stock had begun to recover, but Einhorn, Wall Street's Debbie Downer, put a stop to that when he said the burrito chain was a good short candidate, arguing that Taco Bell's Cantina Bowl line would put a dent in Chipotle's profits. I don't see it that way, though. Taco Bell's recent same-store sales bump came largely from the Doritos Locos Taco; in other words, these are much different brands with contrasting product lines. One's gain does not come at the expense of the other. Taco Bell is the home of the 99-cent burrito, and goopy, artificial nacho cheese. Chipotle, on the other hand, competes on quality, staking its reputation on local and organic ingredients, cooked and prepared in front of the customer. It's hard to imagine Founder Ells, a fan of the sous-vide cooking technique, with nacho cheese dust on his fingertips.
The good news here for investors is that Einhorn's comments lowered the bar, so a strong report from Chipotle is more likely to lead the stock up to the territory it traded in before the billionaire investor bashed it.
The bloodbath following the last earnings report came largely because Chipotle's stock had appreciated so much in the previous months for little fundamental reason. At $290, shares are much more sensibly priced, and its P/E of 35.2 is comparable to Panera's (NASDAQ:PNRA.DL) at 32.6 or even Starbucks (NASDAQ:SBUX) at 26.9. Chipotle's growth opportunities also still look far more promising than those two peers. It's hard to imagine Panera's brand of bakery/cafes taking hold of Europe, where those businesses are much more entrenched in the culture, the way they have in the U.S., and Starbucks has already expanded to nearly every corner of the globe. Chipotle, on the other hand, is just getting its feet wet abroad with stores in London and Paris, and the nascent ShopHouse concept offers an additional revenue stream.
Most important, though, is that analysts seem to have given up on this growth story after the stock's tumble. EPS came in at $2.56 last quarter, yet the Street's consensus is just $2.30 for the third quarter. The restaurant chain increased profitability dramatically in the second quarter as net income grew by 61% and restaurant-level operating margin improved by 340 basis points. The recipe was simple -- increased average restaurant sales and lower marketing costs -- yet the experts seem to think it was a fluke. In the past two years, EPS has climbed from Q2 to Q3, and I see no reason for that to change here. Notably, analysts are projecting a 2% sequential growth in revenue, so margins would have to compress substantially for both of those predictions to come true.
As we saw last time, an earnings beat alone won't be enough -- same-store sales and revenue will also have meet expectations -- but there are enough reasons for investors to look forward to Ells and co.'s update this time around.
Jeremy Bowman owns shares of Chipotle Mexican Grill The Motley Fool owns shares of Chipotle Mexican Grill, Panera Bread, and Starbucks and has the following options: short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend Chipotle Mexican Grill, Panera Bread, and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.