Chipotle Mexican Grill, Inc. (CMG): Spicy Sales with a Small Dash of Caveat Emptor

Consumers’ tastes for Mexican menu offerings are robust in many parts of the world. This is very evident when looking at the latest financial results for Chipotle Mexican Grill, Inc. (NYSE:CMG). The company develops and operates fast-casual, fresh Mexican food restaurants. As of Feb. 5, 2013, they operated approximately 1,410 restaurants. In early February, the company reported financial results for their fourth quarter and full year ended Dec. 31, 2012.

Highlights for the fourth quarter of 2012 compared to the fourth quarter of 2011 include revenue increasing 17.2 percent to $699.2 million. Comparable restaurant sales increased 3.8 percent, and net income was $61.4 million, an increase of 6.8 percent. Their Diluted Earnings per Share was $1.95, an increase of 7.7 percent. However, restaurant level operating margin was 24.6 percent, which represented a decrease of 150 basis points.

Highlights for the twelve months ended Dec. 31, 2012, compared to the prior year include revenues increasing 20.3 percent to $2.73 billion. Comparable restaurant sales increased 7.1 percent, and the restaurant level operating margin was 27.1 percent, an increase of 110 basis points. Net income was $278.0 million, an increase of 29.3 percent. Their Diluted Earnings per Share was $8.75, an increase of 29.4 percent. The company opened 183 new restaurants in 2012.

What are the positives for investors to consider?

The growth in fourth quarter revenue was due to new restaurants not in the comparable base and a 3.8 percent increase in comparable restaurant sales. Chipotle Mexican Grill is being aggressive with new restaurant openings, broadening their network significantly. In 12 months they opened 183 locations – an average of 15.25 locations every month.

The driver of comparable restaurant sales growth was primarily increased traffic. Therefore, via quality marketing and promotions, along with their focus on sustainably raised ingredients and food prep using classic cooking techniques in open kitchens, the company is getting more diners into already established locations.

What is something to be concerned about for investors?

Investors should consider rising commodity costs for restaurants in general and Chipotle Mexican Grill in particular. The company experienced increases in beef costs and increases in the cost of salsa ingredients and dairy. The drop in restaurant level operating margin in the fourth quarters was mainly because of these higher food costs. Food costs were 33.5 percent of revenue in the fourth quarter, representing an increase of 130 basis points.

The United States Department of Labor – Bureau of Labor Statistics reported in November 2012 that the U.S. experienced their worst drought since the 1980s in the summer of 2012 ( referencing: “U.S. Drought 2012: Farm and Food Impacts,” United States Department of Agriculture, Sept. 25, 2012). The report discussed the all too familiar chain reaction of events: dry conditions – crop failure – reduced supplies – price increases.