Conviction Firms For Chipotle Stock's 25% Share Price Increase

Key Points

• Chipotle Mexican Grill reported another smoking-hot quarter, improving value for its shareholders.
• The outlook is robust, but near-term guidance includes an expectation of margin pressure. 
• Analysts' sentiment firms and targets a 25% upside for the stock. 

Chipotle Mexican Grill NYSE: CMG was not immune to the broad market sell-off. Still, its operational quality belied the move and proved it was a buy-the-dip opportunity. The Q2 results continue the existing trends, which include growing comps, store count, and margin. The primary takeaway is that the company built leverage for itself in Q2 and continues to do so today, and shareholder value is improving. The balance sheet highlights include a 43% increase in the cash balance, uber-low leverage, and a 20% increase in equity that supports the high valuation. The stock is valued at roughly double its peers, but how many other restaurant stocks are growing at a double-digit pace, have a fortress balance sheet, and are on track to more than double in size? 

Chipotle Mexican Grill Has Another Smoking Hot Quarter 

The appointment of Brian Niccol to the CEO position was a gift for Chipotle investors that keeps on giving. His focus on operational quality, digitization, and consumer experience drives the company's current success. Chipotle reported $2.97 billion in net revenue, a gain of 18.3% over last year, outpacing the consensus estimate on strength in transactions and ticket averages. Comp-store sales grew by 11.1% on an 8% increase in transactions compounded by a 2.4% increase in check average and increased store count. 

Chipotle opened 52 new stores, including 46 Chipotlanes and one international location. Chipotlanes is critical because it enhances unit and digital sales, leveraging fixed costs into higher margins. Digital sales accounted for 35.3% of the net and are expected to remain strong indefinitely. 

Margin is another area of strength. The company reported a 140-basis-point improvement in the restaurant-level operating margin that carried through to the bottom line despite marketing and ad spending. Systemwide, the operating margin grew by 250 basis points to 19.7%, exceeding forecasts and company guidance. The takeaway is that the 33 cents in diluted GAAP earnings and 34 cents in diluted adjusted earnings are up 33% and 36% YoY, respectively, driving robust cash flows and outpacing the consensus by 625 bps. 

The guidance is favorable but shadowed by an expectation for margin pressure as the year progresses. Not only is the company dealing with consumer pushback after its portion-control efforts, but Mr. Niccol and the company are hesitant to issue more price increases. Moving forward, the story will be about efficiency and cost control; the takeaway is that the margin is strong enough to sustain the growth and capital return outlook, even if there is some contraction. 

Analysts Trim Targets: Range Narrows Around Consensus

The analysts' response is mixed but favorable to the share price because the number of analysts covering it and the narrowing range suggest a firming conviction within the market. MarketBeat tracks 15 revisions from 26 analysts with 15 lowered price targets but to a narrowing range bracketing the pre-release consensus. The consensus price implies a 25% upside for the stock, and the consensus sentiment is firm at Moderate Buy. 

The price action in CMG is up following the release. Early premarket action has the stock up about 2% and showing signs of support at the recent low. If the market follows through with this move, the stock price could advance, and the rebound could be vigorous, possibly setting a new high by the end of the year. The risk is that this market is below critical moving averages that may cap gains given the current broad-market environment. In this scenario, there is a risk that CMG shares will remain under pressure, possibly setting new lows before the rebound begins. The critical support target is near the split-adjusted level of $51.50; if it fails to hold, CMG stock could fall to the $45 level or lower.