Chipotle is on the Hedgeye Restaurants Best Ideas list as a LONG.
Chipotle (CMG) delivered an impressive 2Q15 when you digest the numbers and get past the same-store sales comp miss. Reported revenue was $1.20B missing slightly versus consensus estimates of $1.22B. Same-store sales (SSS) were +4.3% missing consensus estimates of +5.8% by 150 basis points. The build-up of the comp consisted of +4% price, traffic was slightly negative at -0.3% but offset by +0.6% mix driven by catering and kids meals. Diligent management of cost of sales enabled management to deliver a bottom line beat with reported EPS of $4.45 versus consensus estimates of $4.43.
CMG maintained its full-year 2015 guidance for:
- Comps of low-to-mid-single digits
- Unit development of 190 to 205
Given current trends and the outlook for the balance of 2015 the current consensus estimate for EPS of $17.34 appears to be conservative.
A few things that impacted the quarter:
- Poor management of the labor schedule as teams work to integrate the new software caused a $0.16 impact to EPS in Q2. This is expected to be resolved through Q3 and by Q4 management expects to make up some of this headwind.
- Regulatory calls for higher wages, CMG already pays above minimum wage, but to continue to maintain the high quality workforce, they need to stay above it.
- Absence of carnitas is obviously still an issue but with a new supplier online CMG expects to have all restaurants loaded with pork by early Q4. No bounce back from carnitas has been included in company guidance, providing possibility of further upside.
- Commodity inflation, Avocados sourced from California and Beef system-wide will add pressure to the cost of sales line item, but management is adamant to try to pass some of the cost onto the customers.
Although traffic was negative for the quarter management stated that it has turned positive in the low-single digit range in July. We continue to be encouraged by Chipotle’s continued robust growth driven by strong employees and one of the most loyal fan bases. The opportunistic share buyback program will continue to support this stock, as management steers it towards growth for many years to come.
Below is a look at CMG’s performance versus a year ago and consensus estimates for this quarter. Please note that green is positive performance, while red is negative performance.
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Takeaway: Q2 is a wildcard for the stock but 2H 2015 and 2016 headwinds are stiff and valuation is high
CALL TO ACTION
For the first time in many quarters, for any Macau operator, we’re actually in line with Street EBITDA estimates for a quarter. That’s the good news. Lucky play on the Macau VIP tables could be a $30m contributor to EBITDA (3%) and is probably the reason we’re in line. Not exactly bullish but it may be good enough. We’re actually not sure how the stock will react to Wednesday’s Q2 earnings release. However, we believe estimates are ultimately headed materially lower owing to declining [high margin] base mass, falling market share (already happening in July), too optimistic non-gaming expectations and a full valuation.
As you can see from the following chart, Hedgeye is very much in line with the Street for Q2 revenues and EBITDA. It’s unclear whether high VIP hold in Macau is reflected in the Street estimates but it is in the Hedgeye projection. Our projections are not much different than those laid out in our monthly Macau conference call on July 7th.
We don’t have a specific call on the stock action immediately following the Q2 release but do believe the stock is ultimately headed lower. Here are the push and pulls for Wednesday night:
- Dividend – The odds are pretty high and seem to be priced in that there will be no change in the dividend policy. Any softening of management’s tone regarding protection of the dividend would be a huge negative for the stock.
- High hold % – We know LVS held high at Sands Macau, Four Seasons, and Sands Cotai Central. It’s unclear whether high hold is reflected in consensus. In our model, we’re projecting a $30m positive contribution from good luck (3% of overall EBITDA). Gaming stocks will sometimes trade up on a meet or beat even if it is related to luck, but that is usually short-lived.
- Base Mass – Another significantly down quarter in this segment should force down 2015 and 2016 estimates given the high margins in this area.
- Non-gaming - The Street pays little attention to non-gaming revenues as Macau is seen as a gaming market. However, RevPAR and other non-gaming revenues are headed materially lower, much of which will drop to the bottom line. At some point, the analysts' models will have to reflect that.
- MBS – We’re slightly higher than the Street on EBITDA from the Singapore property but this property is always a difficult one to model.
- Forward commentary – While management may positively spin some of the government signals of late, the data suggest July is not a good month for the market, nor is it good for LVS. How much of LVS’s 2%+ share loss vs trend is due to new competition from Galaxy Phase 2 and how much is hold related? Phase 2 does seem to be ramping, at the expense of the market, and it is targeted at LVS’s core segments.
While our Q2 estimates are consistent with the Street, we remain well below for 2015 and 2016 as shown in the chart below. Our primary concern remains the trend in Base Mass – the highest margin segment - that appears to be eroding faster than the Street expects. Our analysis of average minimum table bet levels (see our most recent analysis, “MORE MACAU PRICE CUTTING” on July 10th) shows more elevated minimum bet cuts for Base Mass than even Premium Mass.
The following chart shows the breakdown of Mass between Premium and Base for the last several quarters for Sands China. Following a flattish Q4, Base Mass revenues began to fall YoY in Q1, 2 quarters behind the first Premium Mass decline. We believe Base Mass will continue to decline, possibly throughout 2016 which will have significant margin and EBITDA ramifications.
Moreover, we think LVS market share is at risk. Following a few hold-aided months, market share appears to be headed south. At 22.0%, LVS’s market share is tracking 220bps below recent trend during July month to date. Galaxy Phase 2 has not grown the market and appears poised to continue to steal share, much of it from LVS. Supply growth over the next 2 years will be aimed squarely at LVS’s Base Mass segment. The hotel segment and other non-gaming should also be a drag on YoY profitability with room supply peaking at ~25% next year in an already declining rate environment. LVS is the most exposed operator to rooms.
Stock action on Thursday could go either way but the intermediate trend in the stock price should be lower. There are just too many headwinds for the Macau market in general and LVS in particular to justify a 13-14x EV/EBITDA multiple, at the high end of the historical range.
SBUX reports Q3 2015 earnings after the close on Thursday, July 23, followed by a conference call at 5pm ET. The consensus is looking for revenues of $4.86 billion, up 17% and EPS of $0.41, up 21%. We see little upside to current consensus estimates.
We are adding SBUX to the SHORT bench of our Hedgeye Restaurants Best Ideas list.
SBUX obviously has significant growth potential, and has had industry leading innovation as of late. But we are growing increasingly concerned by the valuation of the stock, which trades at nearly 2 standard deviations above the five year average EV/NTM EBITDA of 12.9x. The current valuation more than adequately reflects the company’s long-term growth potential. That being said, we do have some reservations about the current growth strategy.
Some of the issues on our radar screen are:
- We are closely watching the amount of items they are adding to their menu, as they may be overcomplicating it, which if history proves right again, would decrease performance of the stores.
- Is the latest round of mobile order and pay improving throughput?
- CAP region sales and margin trends.
SBUX shares are up 35.75% year-to-date versus up 3.29% for the S&P 500. One turn on the EV/NTM EBITDA multiple suggest 5.9% upside/downside in the name.
Looking out to 3Q15, SBUX should achieve its 22nd consecutive quarter of same-store sales growth of 5% or greater, which is an impressive feat given their large store base. Imbedded in the 3Q15 performance we are looking for management commentary about the Mobile Order & Pay as well as performance of food items across all day-parts. Same-stores sales will slow sequentially in 3Q15, but traffic trends are estimated to accelerate globally.
SBUX’s margins have benefited from a significantly higher average check. The check has been rising at a steady 3%-5% for the past five quarters; consensus is expecting these increases to tail off to the 2.5%-3.5% range over the next four quarters.
Traffic growth has been historically low over the last five quarters coinciding with the historically high price increases. Management is banking on innovation and Mobile Order & Pay to get traffic back up. The acceleration in traffic is critical at this valuation, especially in the Americas. Watch out below if traffic decelerates sequentially in 3Q15.
RESTAURANT LEVEL MARGINS
Globally, SBUX is expected to see Restaurant Level Margins accelerating, but at a slower rate than in 3Q14. Margins expected to increase 84 basis points YoY to 28.41%, compared to a 205 basis point increase in 3Q14.
Globally, SBUX should see operating margin expansion in every region except CAP. On a consolidated basis, operating margins are expected to be 19.18% in 2Q15, up 68 bps year-over year. The company should benefit from favorable coffee prices, and supply chain initiatives taking costs out of the system.
SENTIMENT AND VALUATION
EV / NTM EBITDA
Trading at 16.9x EV/NTM EBITDA the stock is not cheap, and is due for a correction. Long-term we are bullish on SBUX, but we are growing skeptical of the current valuation and product line extensions. For example, if the stock were to drop down to 15x EV/NTM EBITDA, 1 standard deviation above the five year average, it would imply a ~12% decrease to todays price. This is a scenario we believe to be likely, but with the upcoming quarter and current excitement around Mobile Order & Pay we wouldn’t want to get in ahead of the print.
Realistically we see about ~20% downside in this name if our thought process plays out. Before being fully convicted on this idea we need to hear management’s commentary during the Q3 call. Post the call we will give you our higher conviction take on the outlook for the company.
SBUX’s short interest is low, hovering right around 1% of the float. There is not a big bet against this company.
With 79% of the analysts having a buy rating on the stock and zero sell ratings, there is a very strong positive bias to the name. Given the financial performance of the company for the past two years, the bullish bias appears to be justified. But the future looks murky, as the over complication of the menu has the potential to spell serious trouble.
HEDGEYE RESTAURANTS IDEA LIST
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