Chipotle Mexican Grill (CMG 0.17%) may finally be losing some of its heat.
The high-flying burrito roller has been delighting investors for years with seemingly endless growth, but its most recent quarter showed that it may now be aging past its heady days of youth. For the first time in six quarters, the fast casual chain missed earnings estimates.
But the greater concern is its slowing sales growth. Top-line revenue increased just 12.2% in the quarter, while comparable sales ticked up a modest 2.6%. Even worse is that management is projecting same-store sales growth next year of just low-single digits, which would be its worst performance since the recession.
CMG Revenue (Quarterly YoY Growth) data by YCharts
As the chart above shows, Chipotle's revenue growth was this slow twice in its history as a public company -- but both times it bounced back immediately. This time around, management expects slow organic growth to continue into next year, and analysts are only projecting a 14% revenue increase in 2016.
Chipotle's revenue growth has always been somewhat cyclical, as management was quick to point out, and CFO Jack Hartung has often said that comps tend to track in three-year cycles.
Source: SEC Filings
While there has been an ebb and flow to Chipotle's comps, the overall trendline is clearly decreasing. 2014 was a standout year, but same-store sales that year were juiced by an across-the-board menu price increase. With the exception of the recession-plagued years of 2008 and 2009, the burrito chain's three worst comp growth years have come in the last four years, and 2015 should be even slower once the year is complete.
There are other factors at play here besides history and a maturing brand. Let's take a look at the other key reasons why Chipotle's growth is unlikely to return to its former heights.
Throughput
Probably the most important concept in understanding Chipotle's growth is throughput -- the number of customers it can serve in a given time period. Every earnings report, Co-CEO Monty Moran dutifully highlights throughput and touts the company's efforts and results in improving its speed of service during peak hours. For the first time in recent memory, throughput declined during its peak lunch hour -- by one transaction an hour -- while it improved by just one transaction an hour during the peak dinner period. In other words, Chipotle's speed of service seems to be plateauing after several years of growth. It's only natural. The restaurants can only move so many people through at peak hours, and the longer the lines grow the more likely customers are to skip a lunchtime burrito.
Chipotle has begun employing a second make line at some restaurants, which is boosting sales by an average of $500 a day and should relieve some of the burden of increasing volume, but the constraints of its assembly line service system are becoming clear.
Real estate
Chipotle's average annual restaurant sales have now reached $2.5 million. Of the major national restaurant chains, only privately held Chick-Fil-A does better at $3.1 million. At $2.5 million, Chipotle is even with fellow fast-casual star Panera Bread Co(PNRA +0.00%) and McDonald's Corporation (MCD +0.75%), which has been the dominant fast food business for decades. Though McDonald's has struggled in recent years, its systemwide sales in the U.S. are still nearly triple that of any other chain at $35 billion, making its popularity unquestionable. Chipotle has managed to equal Mickey D's in average unit sales, and will likely pass it this year, without the benefit of drive-thrus, breakfast, or 24-hour locations, which are all major sales drivers for McDonald's.
What's amazing about Chipotle's success is that it has come without employing many of the add-ons its competitors use. Its restaurants are small without drive-thru; its menu is basic and does not offer limited time offers; and most locations are only open 11 hours a day, from 11AM-10PM.
The size of the average Chipotle is just 2,550 square feet, considerably smaller than many of its competitors. By comparison, the average footprint at Panera is 4,500 square feet, while at McDonald's it's 4,000 square feet, and Chick-Fil-A is in that range as well.
In other words, Chipotle uses its real estate far more efficiently than any other major restaurant chain, driving nearly $1,000 in sales per square foot, double the rate of most major chains. That's a testament to management's real estate strategy and the quality of the product, but it also means that the ceiling on sales at individual Chipotle restaurants is lower than it would be at, say, McDonald's. They just simply don't have as much capacity, and the higher the volume, the harder it is to continue to grow it.
In addition to adding the second make station, management is also focused on its mobile strategy. It recently hired its first Chief Information Officer, plucking Curt Garner from Starbucks, the leader in mobile ordering. On the recent earnings call, CFO Hartung pointed out that although two thirds of orders are consumed outside of its restaurants, only 7% of orders are placed remotely, meaning there is a tremendous opportunity to increase mobile ordering, which would improve efficiency and boost sales. Management also said, however, that it was not quite ready for a full push into mobile ordering as it didn't believe it had optimized the experience yet.
Prices
Finally, there are two ways for Chipotle, or any other restaurant chain, to boost comparable sales -- by either increasing transactions or prices. In 2014, it raised prices across the board by about 6%, and then followed that up this year with a targeted price increase on its steak and barbacoa entrees to help absorb higher beef costs. It also implemented targeted price increases in markets where the minimum wage has gone up significantly, like in San Francisco, where it hiked prices as much as 14% this summer to offset increased labor costs.
The upshot of the recent price hikes and the gradual minimum wage increases that cities like Seattle and Los Angeles have passed means that Chipotle will be less able to implement an across-the-board price increase like the ones we've seen recently anytime in the near future, and will be more likely to rely on a targeted strategy. Co-CEO Steve Ells said, regarding the price increase in 2014, "We believe we've got a lot of pricing power. We're not going to spend all the pricing power we've built up over time, we still have some in the bank." Its price increases have yet to drive away customers, indicating that some power likely remains, but with the price of a beef burrito now $10 in some markets, price hikes in the forseeable future may be more restrained.
Wrapping it all up
The constraints on throughput, the limitations of its real estate, and the recent price increases all indicate that Chipotle's same-store sales growth is unlikely to hit double digits as investors had come to expect in the old days.
But demand for Chipotle's burrito is as high as ever, and its new store pipeline is strong and getting stronger. The company recently upped its guidance for new store openings this year with a record 215-225 new stores, and expects to add 220-235 in 2016. Though top-line sales growth may be stuck in the low teens, Chipotle still has a promising expansion path ahead of it. With just around 2,000 domestic stores currently and demand virtually unrivaled, the company should be able to maintain its 10% store growth rate for 10 more years, if not more, building at least 5,000 domestic locations. Seed concepts like ShopHouse and Pizzeria Locale are slowly expanding, as ShopHouse will soon enter the Chicago market, and international markets present a third significant opportunity for Chipotle. Profitability should also improve as it builds out its mobile ordering system and uses its second make lines more.
Over the long term, I still expect the burrito roller's stock to outperform the market, but it will be more difficult than it has been for the company to drive growth at the store level.
