While comps are improving, but it's getting more expensive for the narrow-moat company to drive restaurant traffic.
We believe there are two key takeaways for investors following narrow-moat Chipotle
's preliminary fourth-quarter update, which calls for a comp decline of 4.8%, restaurant margins between 13% and 14%, and an EPS range of $0.50-$0.58 per share (each of which was modestly worse than we expected). The first is that comps are improving, with trends improving on both a one- and two-year basis. According to management, comps fell 20.2% and 1.4% in October and November but increased 14.7% in December as it lapped 2015's food safety incidents. On a two-year stacked basis, comps fell 19.0%, 17.3%, and 15.3% in October, November, and December, respectively. While risks still loom, including negative sentiment stemming from real or perceived food safety issues and the ongoing U.S. Department of Justice's investigation, we believe that management's full-year 2017 comp target approaching 10% looks more palatable (ahead of our current outlook of 6%).
R.J. Hottovy, CFA, is a consumer strategist for Morningstar.
The more important message from an economic moat and longer-term cash flow perspective is that it is getting more expensive to drive restaurant traffic, with marketing and promotional costs--which totaled 4.7% of sales--running higher than expected and well ahead of historical norms under 2.0%. This validates our concerns about Chipotle's customers becoming more dependent on promotional activity in the future and supports our views that restaurant and operating margins will recover to the low to mid-20s and the midteens, respectively, over the next five years, well below the mid- to high 20s and high teens a few years ago. We also believe that fourth-quarter margin trends suggest that management's 2017 EPS target of $10 will be difficult to achieve, and after adjusting our model, we remain comfortable calling for EPS of $8-$9.
Taken together, we're not planning material changes to our $425 fair value estimate and believe investors should require a wider margin of safety given the lingering potential for volatility in 2017.
Morningstar Premium Members gain exclusive access to our full analyst reports, including fair value estimates, bull and bear breakdowns, and risk analyses. Not a Premium Member? Get this and other reports immediately when you try Morningstar Premium free for 14 days.