Chipotle Mexican Grill, Inc. (NYSE:CMG) Q1 2023 Earnings Call Transcript

Chipotle Mexican Grill, Inc. (NYSE:CMG) Q1 2023 Earnings Call Transcript April 25, 2023

Chipotle Mexican Grill, Inc. beats earnings expectations. Reported EPS is $10.5, expectations were $8.92.

Operator: Hello, and welcome to the Chipotle Mexican Grill First Quarter 2023 Results Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Head of Investor Relations and Strategy, Cindy Olsen. Cindy, please go ahead.

Cindy Olsen: Hello, everyone, and welcome to our first quarter fiscal 2023 call — earnings call. By now, you should have access to our earnings press release. If not, it may be found on our Investor Relations website at ir.chipotle.com. I will begin by reminding you that certain statements and projections made in this presentation about our future business and financial results constitute forward-looking statements. These statements are based on management’s current business and market expectations, and our actual results could differ materially from those projections in the forward-looking statements. Please see the risk factors contained in our Annual Report on Form 10-K and in our Form 10-Q for a discussion of risks that may cause our actual results to vary from these forward-looking statements.

Our discussion today will include non-GAAP financial measures. A reconciliation to GAAP measures can be found via the link included on the presentation page within the Investor Relations section of our website. We will start today’s call with prepared remarks from Brian Niccol, Chairman and Chief Executive Officer; and Jack Hartung, Chief Financial and Administrative Officer, after which we will take your questions. Our entire Executive leadership team is available during the Q&A session. And with that, I’ll turn the call over to Brian.

Brian Niccol: Thanks, Cindy, and good afternoon, everyone. 2023 is off to a great start with first quarter sales and margins ahead of our expectations. For the quarter, sales grew 17% to reach $2.4 billion, driven by a 10.9% comp. In-store sales grew by 23% over last year. Digital sales represented 39% of sales. Restaurant level margin was 25.6%, an increase of 490 basis points year-over-year. Diluted EPS was $10.50, representing 84% growth over last year. And we opened 41 new restaurants, including 34 Chipotlanes. These results demonstrate that our focus on running great restaurants with exceptional food and exceptional people is driving performance. Additionally, we benefited from exciting new menu innovations including Fajita Quesadilla and Chicken al Pastor.

Transaction trends were positive throughout the quarter and the strength has continued into April. I would like to note that beginning this quarter, we are returning to our pre-COVID practice of providing annual comp guidance and anticipate comparable sales to be in the mid-to-high single-digit range for the full-year. We will also continue to provide quarterly comp guidance for the remainder of this year and anticipate second quarter comps in the mid-to-high single-digit range. Now, I would like to provide an update on our five key strategies that will position us to win today while we create the future, which include: number one, running successful restaurants with a people accountable culture that provides great food with integrity, while delivering exceptional in-restaurant and digital experiences.

Number two, making the brand visible, relevant and loved to improve overall guest engagement. Number three, amplifying technology and innovation to drive growth and productivity in our restaurants and support centers. Number four, expanding access and convenience by accelerating new restaurant openings. And number five, sustaining world class people leadership by developing and retaining diverse talent at every level. First, starting with our restaurants. We recently held our Field Leader Conference, which included all Field Leaders, Team Directors’ and Regional Vice Presidents, as well as leaders from our restaurant support center. The message was clear. We are focused on developing exceptional people and preparing exceptional food. It was truly inspiring to see over 600 highly motivated leaders aligned to deliver Chipotle’s standards of excellence and I’m proud of the progress our restaurant teams are making.

We had another outstanding quarter for turnover, with both hourly and salary metrics being some of the best I’ve seen in five years. The stability of crew and managers and a return to shoulder-to-shoulder training is helping to translate Project Square One into results. As our teams are getting more experience, we are continuing to see improvements in each of the Project Square One focus areas, including throughput on the frontline, on-time and accuracy on the digital make line, being prepped and ready with our delicious food, and the overall customer experience. Specifically on throughput, while we are making progress, we see opportunities to do better. One area we are focused on is deployment on the front make line and the digital make line during peak periods.

We have noticed that when the digital make line gets busy, our managers tend to pull a crew member from the frontline to help, which is impacting throughput. We are currently testing changes to the smarter pickup times logic based on different sales and deployment levels in several markets, and early results show that we are increasing throughput on the frontline and increasing on time on the digital make line without impacting sales. Leveraging our stage gate process, we will continue to fine-tune our testing before rolling it out in phases across our restaurants. We have also added an additional incentive for our teams as we recently rolled-out digital tipping across our restaurants as part of our ongoing effort to enhance our crew member benefits.

This will enable our teams to be rewarded for their efforts in preparing delicious food and providing a great experience for our guests. Overall, our focus on being brilliant at the basics and reestablishing our standards of excellence is resonating well. Our teams love to be held to a high standard, because when you achieve it, you feel like you were part of a winning team with the ability to be rewarded through bonuses and growth within the organization. We are starting to feel this again in our culture and in our people. When operations are running better, it helps all other drivers of sales to perform better, such as menu innovation, which brings me to our brand. As we often discuss, we continue to look for ways for the Chipotle brand to be more visible, more relevant and more loved, and we had a couple of very exciting new menu innovations that did just that.

We responded to a real-time opportunity to support our passionate TikTok fans, who wanted Fajita veggies and Chipotle honey vinaigrette as options for our digital exclusive Veggie Quesadilla. We worked with two popular TikTok food reviewers, who made the idea go viral at the start of the year and leveraged our strength in digital marketing and culinary to creating exciting new menu items utilizing all existing ingredients. The results have been outstanding. During the launch, we nearly doubled our Quesadilla business and had two of our top digital sales days of all time. We have decided to make this a permanent menu item as the addition of Fajitas to our Quesadilla along with dipping it in a combination of our Honey Vinaigrette and Sour Cream is really delicious.

The best part is, that it is made of all existing ingredients which limits additional complexity in our restaurants and we continue to see incremental Quesadilla sales because of this launch. We also launched Chicken Al Pastor as a limited time offer. Al Pastor store has been gaining mass appeal in recent years and we tapped into these consumer trends to offer our own spicy spin on Al Pastor with our freshly grilled chicken. As we mentioned last quarter, this is also operationally simple to execute as it is our existing Adobo Chicken cooked on the plancha and then mixed in an Al Pastor marinate. This has allowed for an exciting new menu item, while still maintaining our focus on Project Square One. Additionally, this is the first time we have launched a new menu innovation globally, as it was rolled-out in the U.S., Canada and Europe.

The launch has been a success, and early indications show that it is outperforming Pollo Asado, which was our most successful protein LTO ever. Turning to rewards. We now have 33 million rewards members and we saw a nice pickup in enrollments as we rolled out Freepotle, which was designed to deliver a strong value proposition and attract new members through our transaction-driving rewards program. Throughout the year, our members will receive 10 personalized free rewards ranging from a signup cloth, to a bag of chips, to a free fountain drink. In addition to driving enrollments, we also saw an increase in member engagement as Freepotle gained traction throughout the quarter. Shifting to amplifying technology and innovation. We continue to leverage technology to improve our in-restaurant and digital experiences.

Susan Law Cain / Shutterstock.com

As we mentioned last quarter, we began testing a new grill to improve the overall cooking process for our chicken and steak. The grill is much faster, allows for more consistent execution, and maintains our high culinary standards as it cooks the chicken and steak to perfection with the same sear and char. The feedback from our teams and our guests has been tremendous and we are currently in the process of rolling out the grill to 10 additional restaurants as a part of further validation through our stage gate process. During the quarter, we also rolled out our advanced location-based technology for our app, which allows for a more seamless process for scanning rewards, as it prompts reward members to scan while they are waiting in line. This has resulted in more rewards members scanning for points in our restaurants, which drives further engagement in our rewards program.

For digital orders, it also alerts app users when it appears they are ordering from or heading to the wrong location, as one of our most frequent refund request is due to guest arriving at the wrong restaurant. Since rolling out this feature, we have seen a meaningful reduction in those refunds. We are also investing in technology and innovation through our Cultivate Next Fund to help us scale and advance our Food with Integrity mission. We recently announced two new investments, including Local Line and Zero Acre Farms. Local Line is a leading local food sourcing platform connecting local producers with buyers and helping them digitize their operations and sell products. We believe Local Line will help Chipotle increase the amount of local food for our 3,200 restaurants.

And Zero Acre Farms is a food company that is focused on healthy, sustainable cooking oils made by fermentation that are more environmentally-friendly. Additionally, we recently announced our new Responsible Restaurant Design, which includes features like rooftop solar panels, all electrical equipment and systems, LED lighting, Cactus leather chairs, and electrical vehicle charging stations at select locations. While the pilot will go through the normal stage gate process, we believe it will enable us to take successful elements and incorporate them into future restaurant formats. These investments and initiatives will help to further our purpose of cultivating a better world and reflects our commitment to inspire real sustainable change with a potential impact far beyond our Company.

And this brings me to expanding access convenience with a long-term target of 7,000 restaurants in North America. We remain on-track to grow new restaurants 8% to 10% per year for the foreseeable future, with at least 80% including a Chipotlane. The expansion of Chipotlanes adds additional convenience by adding our unique order pickup channel, which comes with a larger digital penetration driven by the order-ahead business. In Canada, we opened our first Chipotlane in Ontario and we also expanded access and convenience with our recently-announced partnership with SkipTheDishes, which is Canada’s largest food delivery network. Finally, new openings in small towns continue to be a success, with the recent opening of a restaurant in a small town in California that had the second-highest opening day sales ever.

In fact, within the last year, we had our top five openings in the Company’s history, of which four were in small towns. I’ll turn now to sustaining world-class people leadership by developing and retaining diverse talent at every level. Our recent Field Leader Conference was a time to celebrate the achievements and career progression of our teams and I’m always amazed by all the inspiring stories of our leaders. In fact, one of our Field Leaders from the Arizona sub region, who won the award for best throughput has been with Chipotle for 20-years. She is clearly doing a terrific job leading her patch of restaurants. However, what is even more incredible is that she has two sisters, one a Team Director, who has been with Chipotle for 24-years and is consistently a top performer in her region.

And the other is a recently promoted Field Leader who has been with Chipotle for 18-years. Each has a unique story, but all three sisters started as crew members and said that Chipotle changed their lives for the better and gave them the ability to develop and grow others within the organization. When you combine our industry-leading benefits with our tremendous growth, performance culture, and then layer on top exceptional leaders, who will help to grow and develop our future leaders, Chipotle really is a special Company. In closing, I want to thank our restaurant and support center teams for all their hard work in delivering a great quarter. Our focus on getting back to the basics and reestablishing Chipotle’s Standard of Excellence is beginning to drive strong results.

We will continue to develop exceptional people and prepare exceptional food and of course treasure our guests. In doing this, I strongly believe we can make Chipotle better than ever. With that, I will turn it over to Jack.

Jack Hartung: Thanks, Brian, and good afternoon, everyone. Sales in the first quarter grew 17% year-over-year to reach $2.4 billion as comp sales grew 10.9%. Restaurant-level margin of 25.6% increased about 490 basis points, compared to last year. Relative to our guidance, restaurant-level margin benefited from leverage from higher sales, labor efficiencies and lower avocado prices. Earnings per share was $10.50, representing 84% year-over-year growth. The first quarter did not have any material unusual expenses or our GAAP earnings and non-GAAP earnings are the same. As Brian mentioned, we are going back to our pre-COVID practice of providing annual comp guidance. We anticipate comps in the mid-to-high single-digit range for the full-year, assuming we do not see further deterioration in the macro environment.

As a reminder, for Q2 and the full-year, our comp stepped down when we lapped the menu price increase we took in late March of last year, and we anticipate comps will step down again when we lap the menu price increase we took in early August of last year. We’ll continue to provide quarterly comp guidance for the remainder of this year and we anticipate comps in the second quarter in the mid-to-high single-digit range as the transaction trends for the first quarter has continued into April. I’ll now go through the key P&L line items, beginning with cost of sales. Cost of sales in the quarter were 29.2%, a decrease of about 180 basis points from last year. The benefit from last year’s menu price increases and lower avocado prices more than offset a mixed headwind from the Garlic Guajillo Steak limited time offer which ended in mid-February, as well as higher prices across several items including queso, beans, rice, salsa and tortilla.

For Q2, we expect our cost of sales to remain in low 29% range. The mix benefit from the Chicken Al Pastor limited time offer and lower dairy costs will be offset by higher costs in other areas, most notably avocados. We anticipate avocados to increase from the current favorable levels, which are some of the seasonally lows we have seen in the past few years. Labor costs for the quarter were 24.6%, a decrease of about 170 basis points from last year. The benefit from sales leverage was partially offset by wage inflation. For Q2, we expect our labor cost to remain in the mid-24% range as continued labor inflation will be offset by leverage from seasonally higher sales. Other operating costs for the quarter were 15.3%, a decrease of about 110 basis points from last year.

This decrease was driven by sales leverage and a decline in delivery expenses due to lower delivery sales, partially offset by higher costs across several expenses, including natural gas and maintenance and repairs. Marketing and promo costs for the quarter were 3.2% and in Q2 we expect marketing costs to step down to the mid-2% range, with the full-year to come in right around 3%. In Q2, other operating costs are expected to be in the low 14% range. G&A for the quarter was $148 million, which includes $119 million in underlying G&A, $19 million related to non-cash stock compensation and $10 million, primarily related to payroll taxes and equity vesting and exercises, higher performance-based accruals, and costs associated with our Field Leader Conference.

We expect our underlying G&A to be around $122 million in Q2 and continue to grow slightly thereafter as we make investments in technology and people to support ongoing growth. We anticipate stock comp will be around $22 million in Q2, although this amount could move up or down based on our performance. We also expect to recognize about $4 million related to performance-based bonus accruals and payroll taxes and equity vesting exercises, bringing our anticipated total G&A in Q2 to around $148 million. Depreciation for the quarter was $77 million or 3.2% of sales. And we expect depreciation to increase slightly each quarter as we continue to open more restaurants. Asset retirement stepped up to $8.4 million in the quarter. This includes charges related to the replacement of equipment such as fryers, grills, rice cookers and other restaurant equipment as we have been more proactive under Project Square One in preventing ingredient outages.

In the near-term, we expect asset retirements to remain around this level as we continue to prioritize the guest experience and focus on great ops. Our effective tax rate for Q1 was 22.5%, which benefited from option exercise and share vesting and stock prices above the grant values. We continue to estimate our underlying effective tax rate will be in the 25% to 27% range, though it may vary each quarter based on discrete items. Our balance sheet remains strong as we ended the quarter with nearly $1.5 billion in cash, restricted cash and investments, with no debt, along with a $500 million untapped revolver. During the first quarter, we repurchased $132 million of our stock at an average price of $1,553. We increased our level of stock repurchases during the quarter when our share price fell with the overall market and we’ll continue to opportunistically repurchase our stock.

At the end of the quarter, we had $282 million remaining under our share authorization program. We opened 41 new restaurants in the quarter, of which 34 had a Chipotlane and we remain on-track to open between 255 and 285 new restaurants this year, with least 80% including a Chipotlane. We continue to experience challenges including utility installation, component and raw material shortages, and permitting and inspection delays, which have extended our development timeline. And while we anticipate these challenges to persist throughout the year, our pipeline remains strong and we expect to move toward the high-end of the 8% to 10% of openings range once these timeline challenges subside. In closing, 2023 is off to a great start as our focus on strong operations and treasuring our guests is driving an improvement in sales and margin trends.

While we are proud of the progress our teams have made in a short period of time, we recognize that there is still opportunity for us to be even better. We believe that these efforts will position us to successfully navigate through macro uncertainty and more importantly, strengthen our foundation for sustained long-term growth. With that, we’re happy to take your questions.

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Q&A Session

Operator: We will now begin the question and answer session. Today’s first question comes from Dennis Geiger with UBS. Please go ahead.

Dennis Geiger: Great. Thank you and congrats on the strong results. Brian, I want to ask a little bit more about throughput and the operations opportunity. Could you all frame up a little bit more some of the gains that maybe you’re starting to see over this past quarter from Project Square One and some of the other initiatives that you spoke to? And then kind of more importantly, just thinking about the opportunity from here based on initiatives currently in place and maybe even some of the technology you guys have highlighted in recent months? Thank you.

Brian Niccol: Yes. So look, Project Square One has been something we’ve been working very aggressively for probably, I guess now we’re going on almost nine months and our operators have done a terrific job. Scott and the team have really, I think, retrenched on getting back to the basics. And some of things where we make great progress on are just being in-stock with great culinary. We’re experiencing too many times where we’re out of guac, we were out of chips, we were out of chicken, so we’ve made tremendous progress on that front. We also have made a lot of progress on keeping both lines open from open to close. And both of those reasons that we’ve improved dramatically are driven by I think more stability in the restaurant with better training and then holding people accountable to those standards.

On the throughput side of things, we’ve made some progress on the frontline, we’ve definitely made some progress as it relates to being on time and accurate digitally, but we still believe there’s a lot of room for improvement. I think you heard in our prepared remarks, we’re still working through I would call it better deployment in managing during peaks. So that we service the DML business effectively without jeopardizing the service of the people that are right in front of us in the restaurant. So we still believe there’s a lot of runway in front of us on great throughput. We won’t get the great throughput though if we don’t have great stability and great culinary having both lines open from open to close, and we’ve made tremendous progress on those foundational elements.

So really proud of where the team has moved the organization, but I’m really optimistic about where they can get to.

Dennis Geiger: Appreciate that, Brian. And then just a quick follow-up on that. Just some of the tech stuff that maybe is still a little bit early days. How exciting is that for you and what that can do either for throughput, as well as maybe some cost efficiencies as we think about the potential there?

Brian Niccol: Yes, no thanks for the – thanks, I forgot to answer that part of your question. So thanks for the reminder. Look, tremendously excited, that’s why we’re investing in it, right. These clamshell grills that we’re rolling into 10 restaurants now make the job easier, make the culinary better and make the culinary more consistently better. So that’s a huge win for our customer and our employees. I think I’ve talked about this, it makes the cooking time dramatically go down. So chicken goes from 12, 13 minutes to two, three minutes and you get perfect sear, perfect char, just really delicious culinary. So that’s a big unlock for us, because the grill position is one of the hardest positions to train. So we can make that job easier and then we also free up more space on the plancha, it just eliminates any potential bottleneck for our future growth.

The other thing, it’s a huge exciting one for us, it’s a little further out, is Hyphen. We talked about this quite a bit, which is automating the digital make line. That will enable us to be even more accurate, I think probably get a little bit faster and I think give people more consistent experiences. So, all these things are driving towards hopefully better guest experiences, but also a better work environment for employees. And then, obviously with that, I think will be more efficient in both cases. So, really excited about both initiatives. Obviously, the clamshell grills are a little bit closer in. Hyphen is a little further out. And then we’ve got some other exciting initiatives on making our prep easier, right, frying chips or cutting and cleaning avocados.

So, we’re making a lot of investment and we’re going to continue to experiment. Not all of it will work, but I’m confident having innovation in this space is a big unlock for our brand in the long-run.

Dennis Geiger: Great. Thank you, Brian.

Operator: The next question comes from David Tarantino with Baird. Please go ahead.

David Tarantino: Hi, good afternoon. Jack, I have a question on the margin outlook. I think based on your guidance for the second quarter and what you delivered in the first quarter, it looks like maybe the business is doing about a 26% restaurant margin for the first-half of the year or at least that’s what you expect. Is that the right run rate to think about for the year at the current sales levels or is there anything maybe on the horizon in the back-half that might I guess surprise one way or another?

Jack Hartung: Yes, David. In the first half, you’re thinking about it right. We definitely expect our margins to step-up from here. Q2 from a seasonal sales standpoint is a stronger quarter for us. We typically see higher margins in the second quarter. We also have relatively lower marketing in the second quarter and there is some offsets like, like a little bit of inflation in the labor line, but still you’re thinking about it right for the first-half of the year. What’s unknown in second-half of the year is inflation. We’re still thinking there’s going to be continued labor inflation in the mid-single-digit. And even though our commodity has been largely tame, where we’ve had some pluses and minuses that have largely offset each other.

We think in the second-half of the year, there is still the possibility of inflation. For example, we don’t necessarily expect, we’d love avocados to remain at this level for the rest of the year, but we’re being realistic and thinking that may not happen. And there may still be inflation upbeat, we haven’t seen it really yet in what we buy, but there is that possibility as well. So, it’s really a wildcard about inflation up. Inflation is tame in the second-half of the year, that will obviously lead to even better margins in the second-half of the year, but I think you’re thinking about it right.

David Tarantino: Great. And then the follow-up is about your pricing philosophy, and I don’t know if Brian or Jack, you want to take this one. But I guess how are you currently thinking about your pricing as you think about the inflation you just referenced and I think now that you’ve rolled over the pricing in April, you’re running one of the lowest year-over-year price increases in the industry. So, just wondering how you’re thinking about when you pull the lever on pricing again?

Brian Niccol: Yes. Hey David, this is Brain. We’re staying the course on our approach to pricing, which is, if we see inflation that warrants us needing to take additional pricing, we’ll take it. I think we’ve now demonstrated we do have pricing power. We have a really strong brand and we don’t want to be in front of the inflationary environment, but we also don’t want to fall behind. So, the good news is, we’re in a really strong position that when we’re ready and we believe it’s necessary to pull that pricing lever, we can and we continue to have a really strong brand to do it with. So, we have not made any definitive plans on pricing for the balance of the year, but we’re going to stay the course on the approach we’ve taken over the last, I’d say 18, 24 months.

David Tarantino: Great. Thank you very much.

Operator: The next question is from Sara Senatore with Bank of America. Please go ahead.