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Chipotle Smoked as Sales Miss Estimates

Chipotle Mexican Grill's shares plunged Friday as traders revolted against revenue that wasn't to their liking, and they've apparently started having doubts about whether the projected pace of sales deserves their continued support.

Chipotle Mexican Grill
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Chipotle Mexican Grill

The Denver-based burrito and taco restaurant chain posted second-quarter revenue of $690.9 million, up 20.9 percent from the same period a year earlier, but on average, the analyst expectation was $704.8 million, according to FactSet. The range of estimates provided by research analysts was $664 million on the low end, with a high of $723.1 million. Same-store sales were up 8 percent.

Earnings for the second quarter rose to $81.7 million, or $2.56 a share, from $50.7 million, or $1.59 a share, in the same quarter of 2011. The mean projection was $2.30.

But earnings weren't enough. Following the report, Chipotle's stock sank $86.88, or 21.5 percent, to $316.98, and trading was extremely heavy — volume was 15 times the average for a normal session. That's committed selling. The stock, which has traded between $271.53 and $442.40 in the last 52 weeks, was the steepest percentage decliner on the New York Stock Exchange.

"Sales trends slowed during the second quarter, we believe, as a result of a general slowing of the economy and reduced consumer spending," Chipotle Chief Financial Officer John R. Hartung said on a conference call following the results, according to a transcript from Seeking Alpha. "We're not seeing anything that's specific to markets," the transcript quoted him as saying. "It seems like it's a — it's pretty broad based. It's not a significant slowdown, but it is a slowdown."

Room for (Unit) Growth

A sizable number of companies out there would sign up for nearly 21 percent year-over-year sales growth right now, and so would their investors. But when expectations are extraordinarily high, and you come up short, you pay an extraordinary price. That goes with being a high-flier.

Nick Setyan, an analyst covering restaurants at Wedbush Securities, says with a high-multiple stock, typically the multiple is going to at best remain the same when growth is cooling. Chipotle has a price-to-earnings ratio of just under 44, Yahoo! Finance calculates, and investors weren't in a forgiving mood, as evidenced by the reaction in the shares.

"Given all that, the deceleration, in my opinion, was really concentrated around non-peak [outside of rush hours] transactions," he says. Setyan, who lowered his price target on Chipotle to $420 from $480, noted that the company spent less on marketing as a percentage of sales than for any quarter in more than four years, which probably contributed to the sales decline seen in the slower periods of the day. "Off-hours can make or break a comp-sales story," he says.

After considering the latest results and Chipotle's prospects, and even with reducing his target, Setyan says he doesn't believe he's as pessimistic as some other analysts on the company. "I actually raised my EPS estimates in 2012 and 2013, even in the face of declining sales estimates," he says. Chipotle's profitability is much higher than any other company he covers, he says, and he's positive on the longer term.

"This is still the best of all the publicly traded restaurant companies, in my opinion," he says. "Longer-term, they still have the potential to double their current base of units in the U.S." As of June 30, Chipotle had 1,316 locations, and it's planning on opening 155 to 165 new restaurants this year. Adding to the opportunity, Setyan says, are the foreign markets. Now in London and Paris, along with its U.S. and Canadian locations, Chipotle has a chance to have an even bigger set of new diners.

What Have You Done for Me Lately?

Chipotle has been by and large a very rewarding stock in the six-plus years it's been trading, when it came out of McDonald's and went public in January 2006. The IPO price was $22, and Chipotle ended its first day at $44, so a purchase at that closing price yielded a nine-fold gain into the final quote on July 19.

However, it hasn't been perfect. Going back to the December 2006 quarter, this latest sales result marks the seventh time Chipotle has been shy of revenue estimates, though it hasn't happened since the final quarter of 2009. And in fairness, it is by far the worst percentage shortfall of them all, coming in 13.8 percent below estimates, FactSet shows. There's no doubt that's cause for some consternation.

Still, the Friday trouncing seems perhaps a touch extreme when viewed in the context of Chipotle's past sales growth. Though the 20.9 percent increase was the slowest quarter since June 2010, it's not a deceleration of the nature that suggests the time to panic clearly is at hand.

While companies often struggle to maintain accelerating sales as they become larger, this isn't the first time Chipotle has had to deal with a decline in the rate of gain, when quarters are put up against their prior-year comparisons. From the final quarter of 2008, when revenue rose 19.5 percent from the previous year, sales growth slowed, year-over-year, for four consecutive quarters before restrengthening in 2010. Specifically, the sales increases were 16.1 percent, 14.1 percent, 13.8 percent and 12.2 percent in that time frame. The next quarter picked up to 15.6 percent, then Chipotle had nine consecutive quarters of 20 percent-plus sales improvements, including the most recent one.

To Thursday's closing price of $403.86, Chipotle was up roughly 22 percent in the past year, according to Yahoo! Finance data. Over the last two-year period, it's been even better, rising 210.1 percent, making it the third-best performing stock on the S&P 500 in that span. It's the No. 4 stock on the S&P in the last five years, with a gain of 361.9 percent, FactSet says. When you get that kind of reputation, you've got to be awfully impressive to keep pulling in the believers and buyers.

As part of its forecast, Chipotle is calling for a same-store sales increase in the mid-single digits for the full year. On average, FactSet indicates that Wall Street is looking for a top line of $703.9 million for the September quarter, with a range of $681.3 million to $716.3 million among the 21 analysts surveyed. If the mean is hit, that's 18.9 percent growth from the comparable period in 2011. Analysts are looking for $698.9 million in sales for the December quarter, which would equate to a 17.1 percent year-over-year climb.

Good, but is it good enough? As noted above, Chipotle has dealt with slowdowns before, albeit when it was smaller and outsized growth was easier to come by. Now it's dealing with a sluggish economy and with an investor base that's gotten very used to large returns. This is, unfortunately, sometimes how you get rewarded for a slip.

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