Chipotle Mexican Grill (NYSE:CMG) made headlines a few months ago when it announced it was raising menu prices for the first time in several years to combat increasing food costs. While raising prices can often be a scary concept for a restaurant company and its investors, Chipotle remains in a unique position to do so as a result of its strong brand and industry positioning.
Rising costs and menu prices
In Chipotle's most recent earnings release, the company detailed its fight against rising food costs, specifically in beef, avocados, and cheese. As a direct result, its restaurant-level operating margin dropped 40 basis points to 25.9%, while food costs as a percentage of revenue increased 150 basis points to 34.5% in the first quarter.
On the company's first-quarter conference call, Founder and Co-CEO Steve Ells explained:
Beef prices are expected to continue to move higher as supply remains tight while livestock producers try to rebuild the herds and recover from two years [of] record droughts. And generally U.S. beef prices set recent all-time highs. And our steak prices have also hit all-time high recently, rising 11% in the quarter compared to [the fourth quarter] and despite another 14% in April so far. So our steak is up 25% already since the fourth quarter. Cheese prices are also expected to be up [more than] 10% this year and avocado costs will also continue to rise as we're just now entering the season of buying avocados from California again.
To combat these rising costs, Chipotle management announced it was planning to increase menu prices by mid-single digits beginning in the second quarter. Since the planned increases will be done in a strategic way, taking into account specific markets, Chipotle will be able to remain competitive with peers in terms of price.
As any efficient management team does, Chipotle's leadership identified a problem and put in place a viable solution. However, the company's menu-price increases are not just a positive in the short term; they have long-term benefits as well.
While prices for foods like avocados are expected to continue to rise for some time, as co-CEO Ells explained in the statement above, they will not rise forever and will most likely correct. Chipotle's menu-price increases, however, will remain in place, which will benefit the company's overall earnings-per-share performance. This is already being reflected in recent analyst upgrades for the company.
When compared to fast-casual competitors like Panera Bread (NASDAQ:PNRA.DL), Chipotle is already well ahead in terms of EPS performance. According to Yahoo! Finance, analysts expect Chipotle to grow EPS 20.2% in 2014 and 27.2% in 2015. On the other hand, Panera is only expected to grow EPS 2.8% in 2014 and 11.6% in 2015.
One thing that should not be questioned is Chipotle's revenue growth. The company has excelled in this regard for years, and all indications suggest it will continue to do so going forward. The company grew revenue 24.4% in the most recently reported quarter, driven by robust same-store sales growth of 13.4%. In the comparable quarter, Panera only managed to grow revenue 8% and same net bakery-cafe sales a meager 0.1%.
Chipotle's strength highlights one main point: Demand for the company's food products is still incredibly strong, much stronger than offerings from competitors like Panera. This means that the company's menu-price increases should not have an impact on in-store foot traffic.
So far, Chipotle management has not noticed a decline in foot traffic despite having raised menu prices at approximately one-third of its restaurant locations already.
Investor have no reason to fear Chipotle's menu-price increases, as the company is implementing the changes methodically and has the brand strength and customer loyalty to do so without impacting sales growth. In fact, investors should embrace the menu-price increases, as higher prices will begin to contribute to more robust earnings-per-share performance in the current quarter and beyond.