Setyan noted that Chipotle generated roughly $2.5 million of sales per restaurant before its recent food safety issues. He argues that even in a best-case scenario, Chipotle won't get back to $2.5 million in sales per restaurant until 2018. Furthermore, Setyan states that enhanced food-safety measures will continue to crimp Chipotle's margins even if sales recover.
These underlying assumptions don't seem far off base. But even if Chipotle experiences a slow sales recovery over the next two or three years and has to spend more on food safety, it could still deliver big gains for investors.
Sales continue declining rapidly
After a series of food safety lapses in late 2015, Chipotle's sales collapsed. For example, in January, Chipotle's comparable restaurant sales plunged 36.4% year over year. Last month, the company disclosed that the comp sales decline moderated to 26.1% in February and 21.5% in the first week of March.
However, the trend worsened again in the second week of March, with comp sales declining 27.3%. This was likely caused by news that a Chipotle restaurant in the Boston area had been closed after an employee tested positive for norovirus (a common foodborne illness). While no customers became sick, the headlines still affected sales.
We will find out later this month how fast sales recovered from this recent speed bump. Since Chipotle's food safety procedures worked -- keeping customers safe -- there's a good chance that sales bounced back quickly.
Sales per restaurant heads for $2 million
Chipotle's sales per restaurant peaked at $2.53 million in the second and third quarters of 2015. After Chipotle's comparable restaurant sales declined 14.6% in Q4, sales per restaurant receded to $2.42 million.
Chipotle appears to be on pace to post a 25% to 30% comp sales decline for the first quarter. That means sales per restaurant declined at a faster clip than in Q4 2015 and could have fallen as low as $2.2 million for the trailing 12 month period through March.
Even if the sales trend improves by a few percentage points each month going forward, comp sales probably won't turn positive again until the comparisons get much easier in Q4. As a result, sales per restaurant will likely drift down to around the $2 million mark by the end of Q3.
But Chipotle is capable of rapid growth, too
Fortunately, Chipotle has shown over the course of many years that it can grow sales in a hurry. During 2014, sales per restaurant surged from $2.17 million to $2.47 million.
If Chipotle can avoid any further food safety scares, it should be able to return to strong comp sales growth by the end of 2016 -- helped by the easy comparisons it will face. Based on the company's track record of strong growth, a return to $2.5 million in sales per restaurant by 2018 seems manageable, though it isn't a sure thing.
Chipotle would still be very profitable
It's true that Chipotle won't have quite as high a profit margin even if sales recover. The company estimates that its food safety initiatives will reduce its restaurant-level operating margin by about 2 percentage points in the long run due to higher food costs.
Chipotle should be able to offset some of this pressure by spreading its overhead expenses over higher sales volumes as it expands. But to be conservative, let's assume that the company's pre-tax margin declines by a full 2 percentage points compared to pre-crisis levels.
In the 12 months ending in September 2015, Chipotle earned a pre-tax profit of $853 million on revenue of $4.57 billion, good for a pre-tax margin of roughly 18.7%. A 2 percentage point reduction to 16.7% would still leave Chipotle with a very healthy pre-tax margin.
Meanwhile, Chipotle has been growing its restaurant count at a consistent double-digit rate. At its recent pace of restaurant openings, it could have nearly 2,500 locations by the beginning of 2018 and around 2,700 by the end of that year.
Assuming that there are an average of 2,500 restaurants operating in 2018, if sales recover to $2.5 million per restaurant, Chipotle would generate revenue of $6.25 billion. That's far above its previous high. With a 16.7% pre-tax margin, Chipotle would earn a pre-tax profit of $1.04 billion.
Based on Chipotle's normal tax rate of 39% and a share count of around 31 million, this would produce more than $20 in earnings per share. Using a trailing price/earnings ratio of 40 -- which is significantly below Chipotle's historical average -- the stock could surpass $800 by the end of 2018.
Of course, to reach this level, Chipotle needs to win back its customers and find new ones to support its ongoing expansion. I think Chipotle has a good chance to succeed, but the jury is still out. However, investors shouldn't worry if the recovery takes a few years or if Chipotle's profit margin is lower at the end of the process. A slow comeback would be just fine.