The Pricing Void
The tone of the CMG earnings call was very different and defensive - during the earnings call, the CFO contradicted the CEO on the trends in the business during 4Q22. This was the first quarter in the Brian Niccol era that the company missed on Rev, SSS & EPS in the same quarter; 4Q22 Non-GAAP EPS of $8.29 missed by $0.60, and revenue of $2.2B (+11.2% Y/Y) misses by $30M, and comps of +5.6% missed FactSet +6.9%.
In 2022, CMG sales grew 14% to reach $8.6B, driven by an 8% comp (peaking at 10% in 2Q22 and ending at 5.6% in 4Q22) with traffic decelerating thru the year as the company aggressively raised prices. For the year, digital sales represented 39% of sales and 37% in 4Q22, with a delivery order down 15% in 4Q22. The restaurant-level margin was 23.9%, an increase of 130BPS YoY, and (A) diluted EPS was $32.78, representing 29% YoY growth. In 4Q22, the business slowed as growth was impacted by a lower-than-expected benefit from the LTO ( a risk we highlighted in our CMG SHORT DECK) Garlic Guajillo Steak and a headwind from loyalty accounting. For the quarter, sales grew 11% to $2.2B (18% in-store), driven by a 5.6% comp, with digital sales continuing to represent 37% of sales. In 4Q22, the restaurant-level margin was 24%, an increase of 380BPS YoY, and Adjusted diluted EPS was $8.29, representing 49% growth YoY.
Not on the same page - The CEO said, "Our transaction trends improved throughout the quarter as we lapped brisket, and I’m pleased to report that our underlying trends have further improved entering 2023, with transaction trends turning positive." Later in the call, the CFO said, "frankly, we started the quarter soft, and we ended the quarter soft."
Why was the CEO trying to sugarcoat his reality? Trafic only improved in January due to easy comparisons. It is clear by nearly every measure the business is slowing. It's inevitable! Now his reality is to deal with the consequences of raising prices aggressively, and was this the right move or a strategist miss-step? Was the decision to raise prices to protect margins (to get paid incentive comp?) It now looks like aggressive pricing impacts how consumers interact with the brand. What are the implications for future traffic trends and profitability?
Missed revenues and same-store sales - The company opened a recorded number of stores in the quarter but missed new unit openings, with the number of restaurants at the end of the quarter at 3,187 stores vs. the Factset estimate of 3,195. CMG missed on same-store sales, reporting a +5.6% vs. FactSet's +6.9%. The components were 13.5% pricing; traffic was down by about (4%) vs. (1%) in 2Q22; the mix was down by about (3%.), and the breakage was a 0.8% hit. These trends will only slow from these levels.
Current trends and the company's guidance suggest they will miss estimates in 2023!
The pricing void - The CFO said he doesn't want to raise prices in 2023 "just to cover a lap over last year"; he has no choice but to raise prices. CMG is seeing traffic decelerate, and customers are spending less (the mix is negative). On the call, management reiterated its promise that they can do $3.0MM AUVs and 27% RLM. The street estimates for earnings in 2023 and 2024 reflect that guidance, and given current traffic and mix trends, they need to raise prices to hit those targets. CMG is currently running pricing right now of 9%-10%. Pricing begins to roll off early in 2Q23 and mid-3Q23, plus lapping delivery pricing adjustments. For 2023, CMG will have "mid-single digit pricing," but "by the time you get to the end of the year, we’re running basically zero pricing." As SSS decelerates, so will the EPS multiple.
The company will definitely raise prices by 4Q23! How will consumers react to further pricing moves?
Breakage is bad - "there was 30BPS of additional or reduced breakage." The good news is that CMG has loyal consumers, but the bad news is that CMG has loyal consumers looking for free food. To drive engagement and enroll new members in 2023, the company recently introduced Freepotle, which offers each Rewards member 10 personalized free Rewards throughout the year. What if a loyal consumer wants free queso?
What if new and current loyal consumers only use the brand when they get free food and not a full-priced meal?
The LTO Treadmill - in 4Q22, the company's guidance for same-store sales was too aggressive because the quarter had a lower-than-expected benefit from the Garlic Guajillo Steak LTO. Is this a one-quarter issue, or is something else missing? Time will tell, but 2023 will consist of one to two LTOs with Chicken Al Pastor ready to roll out soon. "This new menu item is operationally simple to execute while providing a new exciting flavor that drives transactions and sales." Are CMG loyal consumers looking for Chicken Al Pastor from CMG? "Prepared in small batches throughout the day, Chicken Al Pastor is made with Responsibly Raised®, freshly grilled chicken seasoned with a powerful marinade of Chipotle's signature adobo, seared morita peppers, and ground achiote with a splash of pineapple."
Does this seem simple to execute?
New Grill technology - This is a little concerning and raises many questions. Like some of the issues that SBUX faces growing AUV's come with challenges. It's much harder to manage a Chipotle making $2.8 million annual sales than $1.9M. Why does the company need a new grill, and will they need a complete kitchen remodel in the coming years? The CEO said, "First, we are currently testing a new grill to improve the cooking process for our chicken and steak. The grill is much faster and has consistent execution, which lowers the learning curve significantly. Importantly, we believe it maintains our high culinary standards and can cook the chicken and steak to perfection."
Do they need the new grill to get to the $3.0 million AUV? Are rollout and training costs in 2024 estimates?
Delivery slowing - delivery transactions in 4Q22 declined by 15%. The CFO said, "I think it been just, again, a normal move away from people getting out and about. And I think there are probably some people who are deciding that while that channel adds a lot of conveniences, a higher price comes with that." The CEO pointed out that there is some shift to order ahead. "That’s probably been the biggest trend that we’ve seen. Obviously, the premium, especially when you operate in our white label execution, is one of those places where you can quickly compare like what’s the difference between ordering delivery vs. ordering pickup, and that’s an obvious one where I think we’ve seen; as a result, people, they toggle between the two and then they choose to order ahead. The more consumers experience how expensive delivery is; they will seek alternatives like not choosing delivery.
We are SHORT DASH!
YUM China
More work to do
YUMC 4Q22 Non-GAAP EPS of $0.13 missed by $0.02, and Revenue of $2.09B (-8.7% Y/Y) misses by $220M. Total system sales decreased 4% year over year, with decreases of 1% at KFC and 6% at Pizza Hut, excluding F/X. Comps (4%) missed FactSet (3.7%), with both KFC (3%) below FactSet and Pizza Hut (8%) below FactSet (1.7%). The restaurant margin missed by (50bps) and the operating margin missed by (170bps). Increases quarterly dividend by 8.3% to $0.13 from $0.12. FY23 outlook: expects capex of $700-900M vs. FactSet $809.5M with plans to open ~1,100-1,300 net new stores. Opened 538 net new stores during the quarter. The restaurant margin was 10.4%, compared with 7.5% in the prior year. Operating Profit decreased 94% year over year to $41 million from $633 million (a 93% decrease excluding F/X), primarily due to the non-cash re-measurement gain of $618 million from the consolidation of Hangzhou in the fourth quarter of 2021. Adjusted Operating Profit increased 152% year over year to $40 million from $16 million (a 189% increase excluding F/X). 2023 Outlook: To open approximately 1,100 to 1,300 net new stores and to make capital expenditures in the range of approximately $700 million to $900 million. FY24 guidance: expects total revenue up by LSD in constant dollars, gross and operating margin expansion, operating earnings to grow by double-digits, and operating cash flow to grow faster than earnings.
