Shares of Chipotle Mexican Grill (NYSE:CMG) got walloped following the company's Q4 earnings report on Tuesday afternoon. Investor concerns that have lingered for the past year concerning Chipotle's profit margin and the sustainability of its growth resurfaced with a vengeance. As of noon on Wednesday, Chipotle stock was down more than 7%.
However, while the 16.8% comparable restaurant sales growth that Chipotle posted in 2014 is clearly unsustainable, the company's long-term growth trajectory remains intact. Furthermore, rising food costs are only a temporary problem. Read on to see why Chipotle stock should continue its market-beating performance in the long run.
Food inflation continues
One issue that continues to aggravate some investors is food cost inflation. Chipotle stock got knocked down last April after the company reported that rapid cost increases for beef and dairy were impacting restaurant-level margins.
However, Chipotle implemented a broad-based price increase last spring. It was able to do this without alienating customers -- indeed, the company posted the best comparable restaurant sales growth figures in its history as a public company during 2014.
Despite this price increase, Chipotle did not fully offset its food cost inflation last year. Chipotle CFO John Hartung stated on the company's earnings call that food inflation averaged 7.5% in 2014. By contrast, the menu price increase averaged 6.3%, and since it was not implemented until the spring, the full-year impact on pricing was only 3.8%.
Hartung stated that Chipotle may raise prices for its steak and barbacoa entrees later this year, as its price increases last year didn't fully cover the higher cost of beef. Some Wall Street analysts questioned why Chipotle hasn't already raised prices on these items.
But Chipotle bears may be missing the forest for the trees. Chipotle has demonstrated its pricing power on numerous occasions. In the long run, if it needs to raise prices, it will be able to do so. Its hesitancy to raise prices every year makes results lumpy, but doesn't impact its long-term margin profile.
Moreover, beef costs are likely to decline eventually. It takes several years for the cattle industry to increase beef supply in reaction to higher prices, but supply will eventually catch up, whether it be in 2016 or 2017. When this occurs, Chipotle's food costs are likely to decline from 35% of sales to the historical norm of about 33%, driving future margin growth.
Recurring concerns about slowing growth also found new life this week. Chipotle stock got slammed after its Q3 results last October after the company projected that comparable restaurant sales would rise in the low-mid single digits during 2015. That would represent a huge change from the 16.8% comparable restaurant sales growth Chipotle delivered last year.
Chipotle stock ultimately overcame those worries to reach a new all-time high last month. However, Chipotle provided new fuel for doubters when it reaffirmed this sales guidance on Tuesday. It also reported that comparable restaurant sales growth slowed sequentially in Q4, from 19.8% to 16.1%, falling just shy of the average analyst estimate for 16.3% growth.
Still, it's important to remember that at this time last year, Chipotle was projecting low-mid single digit comparable restaurant sales growth for 2014. Ultimately, Chipotle delivered double-digit comps, even excluding the impact of higher prices.
That's no guarantee that Chipotle will produce similar results in 2015. Indeed, given the tough comparisons, a slowdown in comparable restaurant sales growth seems likely. But high-single digit comps should be well within reach for Chipotle this year.
Every time that investors have doubted Chipotle in the past few years, the resulting drop in Chipotle stock has created a great buying opportunity for long-term investors. The situation today seems no different. Chipotle remains on track for strong long-term earnings growth, which will lead to superior gains over time for shareholders.