Chipotle’s First-Quarter Results Show it Has a Recipe for Success

Chipotle Mexican Grill’s stellar first-quarter results show that customers continue to favor the company’s natural and high-quality ingredients, but higher menu prices could be on the horizon.

Eileen Rojas
Eileen Rojas
Apr 28, 2014 at 5:56PM
Consumer Goods

Chipotle Mexican Grill (NYSE:CMG) continued to impress with its latest quarterly earnings release. Almost 4 million shares traded hands on April 17, and ultimately the stock price closed at $519.61, down about 6% from the prior day. While the company reported double-digit increases in revenue and comp-restaurant sales, there are some market concerns that the earnings could slow due to rising commodity prices.

For the first quarter ended March 31, Chipotle's revenue increased 24.4% to $904.2 million. Comparable-restaurant sales increased 13.4%, while the operating margin decreased 40 basis points to 25.9%. The company opened 44 new restaurants during the period and plans on between 180 and 195 restaurant openings for 2014. First-quarter net income came in at $83.1 million, up 8.5% compared to last year's first quarter, and diluted earnings per share rose 7.8% to $2.64.

Rising food costs could pose a threat
The drop in the operating margin was primarily driven by higher food costs, while a 130 basis point increase in general and administrative costs came from higher executive pay. Chipotle predicts a high-single digit increase in comp-restaurant sales for 2014, excluding a possible increase in menu prices.

Rising prices can pose a threat to future profits. But it's important to note that the company has no debt, and its generous level of free cash flow, totaling $132.5 million, makes it easier for the business to accommodate higher costs and its plans for more restaurant openings.

What about the competition?
One of Chipotle's rivals is U.S. and Canadian restaurant operator Darden Restaurants (NYSE:DRI), which owns food chains like Red Lobster, Olive Garden, LongHorn Steakhouse, and The Capital Grille. In March the company presented an action plan on how it intends to increase shareholder value. One of its goals is to reduce its selling and general and administrative expenses, especially its selling expenses, which are above the industry average. Earnings have been weak over the past year, and the company has underperformed within its industry.

Part of Darden's long-term strategic plan includes developing LongHorn Steakhouse into a household brand and retaining and expanding its customer base to increase restaurant sales. The spinoff of its Red Lobster business is one of the more critical steps in improving results; the unit has been responsible for increasing the level of volatility and downward pressure for the rest of the company. Red Lobster is expected to benefit from the separation because its customers have become increasingly different than the customer base for the rest of Darden's brands.

Another competitor, Yum! Brands (NYSE:YUM), the operator of popular fast-food chains KFC, Pizza Hut, and Taco Bell, has also been dealing with sales declines, mostly in China. The company reported in its 2013 fourth quarter a 9% decline in full-year EPS, or $2.97 per share. Its 2014 guidance that EPS will grow by at least 20% by year-end was reaffirmed. The fiscal 2013 worldwide operating profit dropped 10%, with a steep 26% decline in China; however, the operating profit did grow 10% at Yum! Restaurants International and 3% in the U.S.

Yum! is expanding its restaurants in emerging markets; and 82% of the development of its 1,952 international restaurants took place in these regions, where high growth is expected. Results for the first quarter of fiscal 2014 showed sales in China rebounding, and overall profit rose 18%. Chinese consumers have finally returned to KFC, where sales at stores open at least 12 months jumped 9% after declining for five consecutive quarters.

My Foolish conclusion
Chipotle currently trades at a rather high valuation -- the company's 2015 forward P/E ratio is 31.8 -- so investors interested in adding shares to their portfolio should consider buying when shares dip in price. Darden Restaurants is reasonably valued given its price-to-earnings multiple and book value. Its decision to spin off Red Lobster should improve its bottom-line results.

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Meanwhile, Yum! Brands' future success may ride on how well it executes its expansion in emerging markets and how it manages the risks involved in having operations in these regions. Yum! trades at 18 times 2015 earnings; the share price declined almost 1% on Tuesday, April 22 after the first-quarter earnings announcement. Year to date, shares have risen 1.6%; several research firms have buy ratings on the stock, making it an interesting addition to one's portfolio.