Chipotle reported a rough third quarter yesterday, and I've lowered my long-term expectations and appraisals in all three scenarios.
The bad news is that unit growth will slow next year.
The good news is that a 5% price increase is likely to go through at 80% of the store base within the next few months.
My updated Base case appraisal of intrinsic value is $335 per share, or $369 with a temporary 25% tax rate, or $407 with a permanent 25% tax rate.
Chipotle's reported a difficult third-quarter report yesterday. Same-stores sales were +1%, but that was aided by 1.1% due to comparing against the prior year's third quarter when there was a revenue deferral that artificially depressed that quarter's revenue. So the true comp was -0.1%.
This is a meaningful slowdown from the 1Q and 2Q same-store sales pace, and is due primarily to two non-recurring items: negative press related to the norovirus incident in July and related to mice in one Dallas location, and the impact of Hurricane Harvey and Irma.
Restaurant margins were 16.1%, up 200 basis points from 14.1% in the year-ago quarter but down sequentially from 18.8% in 2Q. The hurricanes and extremely high avocado prices were primarily to blame.
The company accelerated its pace of share repurchases by buying back 300,562 shares in the quarter at an average price of $341 per share. The stepped up pace of buybacks is definitely puzzling. Management should have known during the quarter that it would announce a much slower unit growth pace and otherwise disappoint investors on the third-quarter earnings call, yet they still bought back shares every month of the third quarter. Why not pause the repurchases given that they must have known they'd report bad news, and then consider executing repurchases at the new lower price? They could have bought back 70,000 additional shares with the same $103 million had they waited until after the third quarter. I don't know what they were thinking on this topic.
The worst part of the release was that the company is slowing its new unit opening pace to 130-150 new units in 2018. That's down from about 190 this year. Given Chipotle creates additional shareholder value out of opening new units, this has to reduce my appraisal of the company's new unit growth opportunity. Management claims this is a 12-18 month slowdown while they improve their existing restaurant operations and that it should reaccelerate towards the second-half of 2019. This is clearly a point of uncertainty though, so I have tempered my new unit opening expectations.
Another negative is that same-store sales in October are running up 2-3%, including a small benefit for deferred revenue. That's a tepid pace, especially considering their is some price increase benefit from raising prices at 500 restaurants running through there.
Having listened to the last couple years of earnings calls, management's tone was notably subdued on this call. While they pointed to several initiatives that they hope to accelerate comps, they sounded less confident than usual that they would gain traction. To be fair, perhaps they are confident but have disappointed investors for so long that they are reluctant to stick their necks out. That is understandable.
The good news is that the company will be raising prices 5% at 900 restaurants in November and will look to do the same at the remaining 1,000 restaurants early next year. That is about 80% of the store base getting a 5% increase for virtually all of next year, so that would represent a 4% lift to 2018 comps from that alone. They have historically seen little to no resistance to price increases, but I'll bake some in and call it a 3.5% comp benefit to be conservative. Management did not provide a forecast for 2018 comps because they want to see queso's ongoing impact and the impact of an improved app with more payment choices and other initiatives. Given the company's digital ordering gains, catering growth, and general second-make line sales gains, I'm willing to assume a 5.0% comp for 2018 in my Base case, including 3.5% from pricing.