Chipotle Mexican Grill reported (pre-announced) 4Q and FY12 earnings after the close. Comps and earnings were in line with consensus expectations and the pre-announced figures but some important metrics, which we flagged in recent research notes, inflected in the fourth quarter. Below, we recap 4Q12 and offer some thoughts on 2013.
From here, we remain reluctant to chase the recent move in the share price. A significant reason behind that is that consensus is, in our view, too optimistic in its view of food and labor costs. See the second-to-last chart of this post for more on this point.
4Q12 Earnings Recap
The broad guidance parameters are unchanged:
The good news for Chipotle this quarter is that New Unit AUV Growth seems to be slowing at a decelerating rate. This is a good sign for revenue growth and returns if the bottoming process plays out.
More of a concern is the margin side of the earnings equation. Food costs are being guided to 33.5% to 34% and labor costs, long a source of margin, could now be turning higher.
If management takes price, which seems likely given the earnings call commentary, then food as a percentage of sales could come in below guidance. The worry is how great of an impact that will have on traffic.
Consensus Metrix shows the sell-side expecting continued labor leverage in 2013. We are less confident; the company’s hiring practices have come under scrutiny and cost of compliance, along with the stated driver of wage inflation, could drive labor costs higher going forward.
Takeaway: After an incredible debt reduction and mgn recovery story over the past yr, $HBI needs to grow organicly, achieve new peak mgns, or aquire
Usually a company’s print will leave us squarely supporting either a bullish or bearish case. But in the case of HBI’s 4Q12, we come out right in between.
On the plus side, HBI is the poster child why you should never count against a company that is paying down its debt to drive EPS. We did not appropriately respect this factor, and it was a mistake. Over the past year HBI pas paid off nearly 40% of its debt, taking interest expense down by $40mm during a time when EBIT was off by $20mm (due to product costs). During that time period, HBI’s stock went from $22 to $38. Yes, the market was partially banking on a materials/pricing-driven margin recovery, but we’re hard pressed to find anyone who owned the stock who did not have debt reduction as part of their core thesis.
Management highlighted this many times on the call – arguably more than necessary. But when we step back and analyze the situation, we could see why. Back in 2006 when Sara Lee spun out Hanesbrands, it did so with a $2.5bn debtload and minimal cash. Rich Knoll wasn’t too happy about it back then, and has had the team focused on reducing debt (balanced with sporadic bolt-on acquisitions) over the past six years. He’s finally got the end in sight. We give the team credit.
After the debt reduction, we really couldn’t find a lot to get excited about. Consider the following.
1) Operating margins in the last two quarters came in at 13%, and guidance for next year has margins at new peaks. This level pegs HBI in line with brands like Under Armour, and within a point of Nike. We know that the businesses are different, but as a simple litmus test we wonder if HBI can consistently operate at a level above those brands.
2) The company noted that a 3-4% digit top line growth rate can be leveraged into double digit EPS growth ‘for a very very long time’. This is consistent with past statements. But with margins at new peaks and the de-leverage story nearly complete, it has to come in large part from top line growth. That’s harder to bank on than deleverage for a company in this business.
3) We give the company credit for investing an extra 3-4% in SG&A in 2013 in advertising – which is something we’ll almost always applaud. But aside from that, there wasn’t much mentioned in the way of major initiatives to drive the top line. We heard a lot about driving efficiency, but ultimately the top line is what will get us excited given that HBI is operating above peak margin levels.
4) Management discussed acquisitions in the context of growth – which is fine. After all, it’s worked for them in the past. Put we’re incrementally concerned that we might need to rely more on deal activity.
In the end, we think that the company is being managed well, and that that the risk of being blown up in this position near-term is not significant at 11x a doable FY13 number. But on the flip side, we simply struggled to find anything that makes us excited to buy this name after such incredible (and well deserved) performance.
We don’t think we’re alone in the group of people that wants to see -- in much greater detail -- how HBI is going to drive its financial model on a go forward basis when it hosts its investor day later this month.
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In preparation for WMS's F2Q earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary.
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