Chipotle's (NYSE:CMG) stock fell hard last week after the company made its fourth-quarter earnings announcement.
Not that there was bad news in the actual results. The burrito slinger delivered 52% higher quarterly profit year over year on a 27% jump in revenue. As compared to calendar 2013, sales improved by 16% in calendar 2014 at existing locations as Chipotle attracted, and quickly served, a record number of hungry customers.
But Wall Street wanted more. Two issues dominated management's recent quarterly conference call with analysts: spiking food costs and a weak outlook for sales growth. Neither of these worries should spook long-term investors, though. In fact, I think shareholders would be making a huge mistake by selling their stock on these concerns.
It takes expensive ingredients to make a tasty burrito
Yes, the company's food costs rose by 1 percentage point to hit 35% of sales. That's high even by Chipotle's premium-ingredient standards. To make matters worse, there's no reason to expect costs to start falling anytime soon. Management forecasts a steady 35% cost of food through 2015.
Chipotle does not plan an across-the-board price hike this year to offset the rising cost of ingredients such as avocados and sour cream. All things being equal, that scenario would suggest shrinking profit margin. But we're actually seeing the opposite.
Chipotle last quarter improved its restaurant-level margin by 1 percentage point to 27% of sales. This dynamic of higher food costs paired with attractive profit isn't a fluke, either. It's a key part of Chipotle's economic model.
"We have chartered our own path for how a restaurant company should be run ... we have shown ... that you can spend more on ingredients not less, still serve high quality food at reasonable prices and have industry leading margins and returns," CEO Steve Ells explained last week.
So while Wall Street would cheer news of a menuwide price hike at Chipotle because it would supercharge sales and profit growth, it would also get in the way of affordability and slow Chipotle's widening consumer reach. Plus, why be in a hurry to jack up prices when profitability is already so strong?
This could be a slower-growth year
Next, Chipotle issued a soft forecast for overall growth in 2015, projecting "low to mid-single digit comparable restaurant sales increases." That would represent a slowdown from the big 17% comp growth it recorded for all of 2014.
For a little perspective, here's the forecast management provided at the same time last year before going on to book that record high figure: "low to mid-single digit comparable restaurant sales increases." Sounds familiar, right?
Sure, Chipotle had the benefit of its first price hike in years to give comps an added boost in 2014. But that only accounted for a piece of its growth. Other operational improvements played an even bigger role, including increasing throughput to drive down wait times, improving the quality of the ingredients, and hiring and training higher-performing staff members.
You can expect Chipotle to keep making progress on all those fronts this year, which makes it likely it will deliver surprisingly high sales growth once again. Investors who panicked and sold after the burrito chain gave its soft outlook for 2014 missed out on Chipotle's best year yet as a public company. In my opinion, today's jittery shareholders risk making the same mistake.