Chipotle Mexican Grill (NYSE:CMG) reported sizzling results for the first quarter of 2014. Margins are under pressure due to rising food costs, but revenue growth is nothing short of impressive, especially when compared to fast-food giants such as McDonald's (NYSE:MCD) and Yum! Brands (NYSE:YUM). Is Chipotle a buy, hold, or sell after earnings?
Hot and delicious
Chipotle was rising by nearly 4.5% on Thursday after investors received the company's latest earnings report with a good appetite. Earnings per share came in below Wall Street analysts' expectations because of cost increases, but the kind of growth the company is producing on the top line is an unequivocal sign of demand health and long-term growth potential.
Sales during the fourth quarter of 2014 jumped by 24.4% to $904.2 million, comfortably above analyst estimates of $873 million. Chipotle opened 44 new restaurants for a total store count of 1,637 units, and comparable-stores sales grew by a remarkable 13.4% during the quarter on the back of both increased traffic and, to a lesser degree, a higher average ticket.
Rising food costs for products such as beef, avocados, and cheese had a negative impact on margins during the quarter, though. Food costs were 34.5% of revenues, an increase of 150 basis points versus the first quarter of 2013.
Restaurant-level operating margin fell by 40 basis points versus the same quarter in the prior year to 25.9% of revenues.
Net income came in at $83.1 million, an annual increase of 8.5%, while diluted earnings per share grew 7.8% versus the first quarter of 2013 to $2.64. This was below analyst expectations of $2.88 per share for the quarter.
Steve Ells, the founder, chairman, and co-CEO of Chipotle Mexican Grill, provided an optimistic assessment of the company's performance during the quarter and its fundamental strengths:
We are delighted that more and more people are choosing to visit our restaurants every day allowing us to deliver double digit comps during the quarter. Our food culture has always been a defining characteristic of Chipotle and continues to set us apart from other restaurants. We are confident that our special food culture will continue to attract more customers to visit Chipotle as customers better understand and connect how natural and high quality ingredients that are freshly prepared result in better tasting food.
Outperforming in a challenging industry
Chipotle's performance looks even more outstanding when compared against traditional fast-food competitors such as McDonald's and Yum! Brands.
McDonald's has been facing stagnant or even declining same-store sales in the U.S. over the last several quarters. The company will report earnings for the first quarter of 2014 on April 22. However, recent trends have been anything but encouraging for McDonald's.
McDonald's reported a decrease of 0.1% in global comparable sales during the fourth quarter of 2013, as a higher average check was not enough to compensate for declining traffic. Performance in the U.S. was even worse, with comparable sales declining by 1.4% during the quarter.
February is showing no signs of improvement. McDonald's reported a decline of 0.3% in global comparable sales and a drop of 1.4% in comparable sales in the U.S. during the month.
Yum! Brands is scheduled to report earnings the same day as McDonald's, so investors will get plenty of information regarding the health of the fast-food industry on Tuesday. However, just like McDonald's, Yum! Brands is facing heavy headwinds in the U.S.
Yum! Brands reported flat comparable-store sales during the full year in 2013, as Taco Bell produced an increase of 3%, but sales at Pizza Hut and KFC declined by 2% during the year. For the fourth quarter of 2013, total comparable-store sales at Yum! Brands fell 2% on the back of declines of 4% at Pizza Hut and 5% at KFC, marginally compensated by a 1% increase in same-store sales at Taco Bell.
The trend toward healthier eating habits, a savagely competitive environment, and weak consumer spending are generating heavy headwinds for most companies in the fast-food business, and industry leaders such as McDonald's and Yum! Brands are not immune to this environment.
Keeping this context in mind, the remarkable performance produced by Chipotle Mexican Grill during the first quarter of 2014 looks even more striking.
Buy, hold, or sell?
Trading at a forward P/E ratio above 36, Chipotle Mexican Grill is certainly priced for growth. However, this exceptional player deserves a considerable valuation premium versus competitors in the industry. As long as Chipotle continues delivering this level of performance, the company is a great candidate to hold for the long term, and any dips that may occur down the road should be considered buying opportunities for investors.