As expected, Chipotle Mexican Grill (NYSE:CMG) reported weak Q4 sales results on Tuesday, following multiple food-safety problems that occurred during the quarter. Revenue declined 6.8% year over year -- the first decline in Chipotle's decade-long history as a public company -- while comparable restaurant sales fell 14.6%.
Despite the steep sales declines, Chipotle is sticking to its growth plans. Management is confident that customer traffic will start to rebound soon, so the company is investing heavily to ensure that it's ready to meet that demand.
Sales declines worsen
Chipotle has faced extremely volatile sales trends since its recent spate of food-safety incidents began. As recently as October, Chipotle was posting comparable restaurant sales growth.
In November, comp sales fell 16% year over year. Initially, comp sales declined about 20% after Chipotle announced that it was closing 43 restaurants in response to an E. coli outbreak. The sales trend quickly recovered to high-single-digit declines after Chipotle reopened those stores, before crashing to a 22% drop after the CDC announced four new E. coli cases.
By the beginning of December, Chipotle's comp sales trend had improved to mid-teens declines. However, after more than 100 Boston College students became ill with Norovirus after eating at Chipotle during the first weekend of December, companywide sales fell dramatically.
For the rest of the quarter, Chipotle posted comp sales declines of more than 30%. This poor performance has continued into January. Chipotle reported during its recent earnings call that comp sales declined 36% year over year last month.
The slowdown in sales hasn't affected Chipotle's short-term or long-term plans for growth. In late October -- i.e., before the E. coli outbreak -- the company raised its guidance for 2015 restaurant openings, calling for 215 to 225 new restaurants, up from its original guidance for 190 to 205 openings.
Chipotle exceeded even that bullish estimate. It opened a record 79 new restaurants during the fourth quarter, bringing its full-year new restaurant total to 229. Chipotle ended the quarter with 2,010 locations. It's also sticking with its plan to open another 220 to 235 restaurants in 2016.
One Wall Street analyst asked the management team why Chipotle isn't slowing its growth until the food safety problems are firmly in the past. Chipotle founder and co-CEO Steve Ells responded that the company expects its new food safety program to reassure customers and lead to a bounce back in sales. If demand growth returns to its previous trajectory, Chipotle wants to have the capacity to meet it.
Indeed, the CDC officially declared last week that the E. coli outbreak appears to be over. Now, Chipotle is starting a big marketing campaign that will run through the end of June, with the dual goal of bringing in new customers and getting lapsed customers to return.
It's impossible to know how long it will take for Chipotle to regain its lost sales volume. CFO Jack Hartung noted that other restaurant chains have recovered from foodborne illness incidents in four or five quarters. If Chipotle follows that trend, it will eventually see a rapid acceleration customer traffic. Management is willing to spend more money in the short term to ensure that the company is ready whenever demand snaps back.
A bumpy year, but a bright future
While Chipotle has suffered severe sales declines because of its food safety lapses, it's notable that sales began to recover quickly after the initial incident. It was only after Chipotle started to garner negative headlines week after week that the sales trend worsened.
This suggests that once consumers are satisfied that it is safe to eat at Chipotle, most will return. For the rest of 2016, Chipotle's primary goal will be to make sure this happens. These efforts will drive up marketing costs and store labor costs, causing a steep decline in profitability.
However, as customer traffic returns to normal levels, Chipotle's profit margin should rebound, too. Meanwhile, thanks to Chipotle's ongoing expansion, total sales should be significantly higher a few years down the road than before these food safety incidents. This means that while Chipotle will suffer steep profit declines for the next few quarters, it will probably return to its former trajectory of strong profit growth thereafter.