Chipotle Mexican Grill, Inc. / (CMG – NYSE) / $422.50

Note: This report contains substantially new material. Subsequent reports will have new or revised material highlighted.

Reason for Report: FLASH UPDATE: 1Q 18 Earnings Update; Beat Expectations.

Prev. Ed.: 4Q17 Earnings Update; Mar 19, 2018.

Flash News Update [Note: earnings update in progress; final report to follow]

On Apr 26, 2018, Chipotle Mexican Grill posted first-quarter 2018 earnings which surpassed analysts’ expectations while revenues were in line with the same.

Adjusted earnings of $2.13 topped the Zacks Consensus Estimate of $1.54 by 38.3%. Earnings also grew 33.1% from the year-ago quarter driven by higher revenues and lower food costs.

Chipotle had a good share of negative publicity throughout 2016 due to an issue of food-borne illnesses that surfaced toward 2015-end. As a safety measure, the company was forced to close several outlets. Ever since then, this fast-casual Mexican chain has been undertaking aggressive efforts to restore its economic model as well as regain customer trust.

In order to chalk out a viable business strategy, Chipotle discarded its former co-CEO model and recently appointed former Yum! Brands' (YUM) executive Brian Niccol as the CEO. Niccol’s expertise in restaurant operations, digital technologies and branding has significantly helped Chipotle in first-quarter earnings.

Revenues and Comparable Restaurant Sales

Quarterly revenues of $1.15 billion met the consensus estimate but grew 7.4% year over year. The revenue growth is primarily attributable to improvement in comps and restaurant openings. The company opened 35 newrestaurants in the first quarter and closed two restaurants, bringing the total restaurant count to 2,441.

Comps in the quarter increased 2.2%, which include an underlying comp sales growth of 2.7% and 50 basis points (bps) impact related to deferred revenues, recognized during the year-ago quarter due to the Chiptopia Summer Rewards program. Comps were driven by an increase in average check, including 4.9% benefit from menu price increase, partially offset by fewer transactions and resistance that have been less than 20%. The check average also benefited from customers, adding queso to their orders, which added about 200 bps.

Costs, Operating Highlights & Net Income

Food costs, as a percentage of revenues, decreased 140 bps to 32.4% driven by cost savings in paper and packaging usage, as well as higher menu prices, partially offset by higher costs associated with preservative-free tortillas.

General and administrative expenses came in at 6.7% of total revenues, reflecting an increase of 20 bps year over year, due to rise in headcount and higher bonus expenses. However, the increases were partially offset by lower stock-based compensation expense as a result of forfeitures of stock during the quarter.

Restaurant-level operating margin was 19.5%, up 180 bps from 17.7% in the year-ago quarter. The upside was primarily driven by lower marketing and promotional expenses, and comps growth, partially offset by wage inflation at the crew and manager level.

Net income in the quarter was $59.4 million, up from $46.1 million in the prior-year quarter.

Balance Sheet

Cash and cash equivalents as of Mar 31, 2018 were $231.8 million, compared with $184.6 million as of Dec 31, 2017.

Inventory totaled $17.4 million as of Mar 31, 2018, down from $19.9 million as of Dec 31, 2017. Goodwill, as a percentage of total assets, was 1.04% at the end of the first quarter compared with 1.07% at the end of 2017.

During the first quarter, the company’s board of directors approved an investment of up to an additional$100 million, exclusive of commissions, to repurchase shares of the company’s common stock.

2018 Outlook

For 2018, management continues to expect comps growth in low single digits and launch 130-150 restaurants.

Effective tax rate is estimated in the range of 32.5-33.5% (up from the previously guided range of 30-31%), including an underlying effective tax rate of about 29% in the second and third quarters, and up to 38.5% high in the fourth quarter as a result of an additional anticipated write-off of deferred tax assets associated with stock-based compensation awards.

MORE DETAILS WILL COME IN THE IMMINENT EDITIONS OF ZACKS RD REPORTS ON CMG

Portfolio Manager Executive Summary [Note: Only highlighted material has been changed.]

Chipotle Mexican Grill Inc. (CMG) develops and operates fast-casual and Mexican food restaurants in the United States.

Of the 27 firms in the Digest Group covering the stock, 19 gave neutral ratings, four assigned positive and four issued negative ratings.

The outlook of the firms on Chipotle has been dealt with in the following paragraphs:

Neutral or equivalent (70.4%; 19/27 firms): Despite appreciating Chipotle’s fundamentals, high rate of recovery of comps and unit growth acceleration., these firms are concerned about margin pressure as a result of expenses incurred to regain lost customers, marketing and food costs. Additionally, rising labor costs, to support the company’s food safety program are dampening margins further. Though the firms are encouraged by the company’s new brand-management efforts and operational initiatives, concerns about the company’s susceptibility to bad publicity remain. Moreover, even though the appointment of new CEO might help in the company’s turnaround, the firms believe that it would not have any near-term impact amid a highly competitive restaurant space.

Negative or equivalent (14.8%; 4/27 firms): These firms are concerned about increased competition, operating cost inflation and risk to Chipotle’s reputation. With Chipotle’s success attracting more competitors, the cost of real estate is going high. Though the company’s “food with integrity” stance has managed to regain consumer trust to a considerable extent, some risks to its reputation persist. The company remains susceptible to bad publicity, given it is high visibility in social media. Further, the company’s susceptibility to food cost increases and labor costs is a matter of concern. Meanwhile, Chipotle appointed Brian Niccol as CEO as part of its turnaround strategy from Taco Bell, a quick-service restaurant. Firms believe that quick service restaurant strategies would not help Chipotle to gain traction.

Positive or equivalent (14.8%; 4/27 firms): These firms are of the view that Chipotle is well positioned on the back of new brand-management efforts and these marketing initiatives will help it counter the challenges posed by the massive food safety scandal. The firms anticipate that Chipotle’s operational initiatives like cheaper restaurant designs, digital ordering and delivery will help to boost its sales and margin. Chipotle also enjoys strong unit growth prospects, capital-efficient growth model and financial stability. Moreover, appointment of new CEO might aid in the company’s turnaround strategies.

Apr 26, 2018

Overview [Note: Only highlighted material has been changed.]

Based in Denver, CO, Chipotle Mexican Grill Inc. (CMG) operates under two high-growth segments of the restaurant industry — quick-casual and Mexican food — in the United States. Moreover, the company focuses on an increasing mix of naturally raised meat and organic products.

Chipotle offers a menu comprising burritos, tacos, burrito bowls (a burrito without the tortilla) and salads. The company is striving to improve food quality by using fresh ingredients and sustainably grown and naturally raised products. Chipotle restaurants also feature free-range, hormone-free pork, natural chicken and other meat products. As of Sep 30, 2017, the company had 2,330 restaurants across the United States and 36 Chipotle outlets outside the country. The company also has eight non-Chipotle restaurants. Further, it holds an equity stake in a consolidated entity that owns and operates seven Pizzeria Locale units, a fast-casual pizza concept. Notably, in March 2017, the company closed all 15 of its ShopHouse Southeast Asian Kitchen restaurants, serving fast casual, Asian inspired cuisine, as the brand failed to meet sales expectations and did not demonstrate the ability to support "an attractive unit economic model.”

For more information on Chipotle Mexican Grill, visit its website www.chipotle.com.

Key investment considerations as identified by the firms are as follows

Key Positive Arguments / Key Negative Arguments
·  Attractive Brand Name: Chipotle offers food freshly prepared from premium ingredients (using gourmet cooking techniques) in an appealing environment. The company is the first in the restaurant industry to provide GMO-free foods. Chipotle’s Food With Integrity program continues to drive growth. Also, increased focus on improved food handling, testing and food preparation procedures also bode well.
·  Unit Growth: The company’s new prototype will allow it to maintain a rapid pace of expansion as it makes use of a 10% cheaper design.
·  Sales-boosting Initiatives: The company focuses on its brand-management to boost sales. It has put focus on digital ordering, menu innovation, targeted customer offerings and attractive marketing campaigns to propel top-line growth. Chipotle has also introduced catering at nearly all of the U.S. Chipotle restaurants and offers delivery service through a number of third-party operators. / ·  Mounting Costs: Labor and marketing expenses are increasing, which is likely to pull down revenues. Higher cost of certain ingredients will also continue affecting the company’s margins.
·  Food-safety Scare: Negative publicity related to food-safety could come back to trouble the company. Notably, Chipotle recently faced investigation at a restaurant in Los Angeles after it was reported that some of its workers had complained of nausea, vomiting and diarrhea to local health officials. This started a fresh round of food-safety scare for the company.
·  Competitive Threats: The company is facing price competition from low cost “value meal” menu offerings of fast-casual and quick-service segments of the industry.
·  Market Share: Chipotle’s market share, particularly in the Mexican cuisine category, is unlikely to increase any time soon as the company already reached 60% saturation in the U.S. last year and is currently facing increased competition. It is not likely that the brand will recover and return to its peak levels of 2014.

Chipotle’s fiscal year coincides with the calendar year.

Apr 26, 2018

Long-Term Growth [Note: Only highlighted material has been changed.]

Chipotle — one of the most recognized fast casual Mexican restaurant chains in the U.S. — boasts a viable business strategy. The fast-casual, a fresh and growing concept, is positioned between fast food and casual dining restaurants. They offer more customized, freshly prepared and high-quality food than traditional Quick Service Restaurants (QSR) in an upscale and inviting ambiance.

The restaurateur offers food freshly prepared from premium ingredients (using gourmet cooking techniques) in an attractive environment. The company has some distinguishing features such as non-standardized layouts, a unique décor, open-view kitchen and an ordering process which allows customers to see the food being assembled.

Meanwhile, in December 2016, the company’s board of directors discarded the co-CEO model and made Steve Ells the company’s sole CEO in order to deal with the ongoing challenges in a better way. In the beginning of 2018, the company appointed Brian Niccol as CEO from Taco Bell and expects growth from these new strategies.

Apart from this, Chipotle is working hard to strengthen its brand and recover sales by shifting its strategy from giveaways, discounts and rewards to new menu items, simplification of restaurant operations, enhancement of guest experience, technology-driven convenience, faster throughput and more aggressive brand marketing. The company particularly continues to make changes to its menu to attract customers. In fact, it plans to accompany any new items with extensive advertising campaigns in order to enhance its effectiveness.

Chipotle is working on strengthening its brand and recovering sales by shifting its strategy from giveaways, discounts and rewards to new menu items, operational excellence, enhancement of guest experience by retraining workers, technology-driven convenience, and more aggressive brand marketing.
The company especially believes that there is an opportunity to excite current customers and attract new ones through thoughtful menu development. In this regard, the company has opened the Chipotle Next Kitchen, where it explores changes to its menu. Notably, the Next Kitchen is primarily intended to test the operational impact of potential new menu items. Post evaluation, the new items are put into wider consumer testing in various markets to determine customer acceptance. Moreover, in order to enhance the effectiveness of the new launches, the company plans to accompany them with extensive advertising campaigns.

Chipotle has also introduced catering at nearly all of the U.S. Chipotle restaurants and offers delivery service through a number of third-party operators. These services will invigorate the company’s potential as a brand and augment the top line, going forward.

The company has ample expansion opportunities in the domestic as well as international markets. Long-term opportunities outside the U.S., which appear to be promising, are complemented by the company’s pace of international openings. It plans to increase the number of total restaurants significantly over the upcoming years.

Apr 26, 2018

Target Price/Valuation [Note: Only highlighted material has been changed.]

Rating Distribution
Positive / 14.8%↔
\Neutral / 70.4%↔
Negative / 14.8%↔
Average Target Price / $307.38↑
Upside from Current Price / 20.3%↓
Digest High / $410↑
Digest Low / $325↑
Number of Analysts with Target Price/Total / 21/27

Risks to the target price include an increase in commodity costs and labor costs, rise in incidents involving food borne illness, change in consumer preferences and increased competition from mid-priced casual-dining chains.

Recent Events [Note: Only highlighted material has been changed.]

On Feb 13, 2018, Chipotle announced that its Board of Directors appointedBrian Niccolas chief executive officer and a member of the Board, effectiveMarch 5, 2018.Earlier, Brian Niccolserved as CEO of Yum! Brands' Taco Bell Division, where he was responsible for the highly successful turnaround of the business.

On Feb 6, 2018, Chipotle posted fourth-quarter 2017 results with earnings surpassing the Zacks Consensus Estimate but revenues lagging the same. Adjusted earnings per share in the quarter were $1.34, up 143.6% year over year on lower costs and higher revenues.