Chipotle Mexican Grill (CMG 0.80%) apparently had no problem navigating the coronavirus pandemic as it relied on its digital skills to find ways to serve hungry customers, increasing sales and profits along the way. This positive performance is evident in the share price, which is up 73% in the last three years, despite falling 21% in 2022.
But what’s on the horizon for this Tex-Mex chain? Here are the bear and bull cases for this seemingly unstoppable one restaurant stock.
Lots of reasons to be optimistic
Since many companies have struggled with tough year-on-year comparisons and macroeconomic headwinds like high inflation and interest rates, Chipotle’s growth remains superb. The business grew revenue by 13.7% in the third quarter, with diluted earnings per share rising 28.1%. Same-store sales grew by 7.6%, proving that existing locations are also growing.
Chipotle has continued to lean heavily on its digital foundation. It launched a rewards program in March 2019 that now has 30 million members. To show how impressive this figure is, Starbucksa company that many consider to have the most robust loyalty program, currently has 28.7 million reward members in the United States.
Chipotle’s ongoing goal is to find ways to enhance accessibility and convenience for its customers, allowing them to order their favorite dishes in more ways. The company expects to open 255 to 285 new restaurants in 2023, with 80% having an attached drive-thru. As more customers use digital ordering channels, Chipotle will be able to drive higher sales volume per store, leveraging its fixed costs and boosting profitability.
As for the macroeconomic environment, Chipotle certainly hasn’t been immune from rising costs throughout its business, particularly for things like dairy products, packaging and tortillas. This has the potential to squeeze margins for their restaurants. Chipotle is in such a powerful competitive position that it has been able to raise menu prices several times over the past year and a half. In fact, the margins improved in the last quarter.
“We know our value proposition remains strong, and we had minimal resistance to our price increase in the quarter,” CEO Brian Niccol said on the third-quarter call. It’s hard not to like a business that is barely shows signs of weakness right now.
While Chipotle has shown it can continue to post solid growth amid a softer economy, it’s hard not to imagine a scenario where the company isn’t hurt if the U.S. enters a full-blown recession this year.
In fact, transaction counts decreased 1% in the most recent quarter, according to Niccol. Management will closely follow this trend, which has been boosted by lower-income consumers frequenting Chipotle less often.
Research by the UK’s Institute for Fiscal Studies has found that consumers focus more on grocery shopping and eating at home when times are tough. Therefore, such changes in consumer behavior will certainly affect Chipotle’s revenues in the near term.
I mentioned earlier how the chain has successfully raised menu prices several times, with no apparent impact on sales. Management does not hesitate to emphasize how great the company’s value proposition is for customers, which has made raising prices an easy strategy.
But there is always a risk that it pushes this advantage too much and alienates customers in the process. If input costs continue to rise, the leadership team will be faced with tougher decisions about how to balance profitability with growth.
Perhaps the most important argument for Chipotle is the current stock valuation. As of this writing, shares are traded at a price-to-earnings ratio of 48. It is much more expensive than its restaurant partners. And it leaves no margin of safety for investors looking to get satisfactory returns in the next few years, no matter how much the company’s growth potential is.
Chipotle’s stock returns in 5 years have not been spectacular, but shareholders must evaluate the positives and negatives.