CMG: COSTS HEADED UP

Chipotle’s bottom line is highly vulnerable to a continued rise in food prices.

CMG is a popular brand and their management team has done a great job in many respects.  One significant factor buttressing the bottom line since the stock price troughed in 4Q09 has been food prices.  As I wrote in my June post, “CMG: WATCH MARGINS”, the favorable commodity environment enabled CMG to attain higher margins from 1Q09 onward.  The company is not locked into many of its ingredients and continued food inflation will likely impact CMG’s earnings potential significantly.  

CMG: COSTS HEADED UP - cmg food margins crb

CMG: COSTS HEADED UP - crb foodstuff

Maintaining comparable restaurant sales in this economic environment will be difficult for all restaurant companies.  There is virtually no pricing (one tenth of one percent) in Chipotle’s comp but it seems that management would be hesitant to carry out such a move with unemployment this high.  As the chart below shows, positive traffic momentum has been instrumental in driving Chipotle’s top line.  If the company can maintain high single digit comparable restaurant sales trends, margins will likely remain healthy.  Slowing comps, however, will amplify the negative effect of food inflation on margins and make leveraging other parts of the income statement more difficult. 

CMG: COSTS HEADED UP - cmg comp detail

Below is a rundown of Chiptole’s commodity setup.  While they are largely unlocked on some items such as proteins and dairy, smaller items like rice, tortillas, and corn are locked for the remainder of this calendar year.  Should prices in these contracted commodities continue to trend higher, margins could come under additional pressure when the contracts expire at year end.

Looking at Chipotle’s commodity setup:

  • Rice is contracted through at least two more quarters (through 4Q).   Clearly, this is a good thing to have contracted given recent climate events in Pakistan and China.  
  • Soy oil and corn are also contracted through two quarters while tortillas have also been locked in for the remainder of 2010.
  • Chicken prices in the second quarter were held lower because the company, due to supply issues, only served 80% naturally raised chicken.  The company is “optimistic” that they can return to 100%.
  • The inadvertent change in chicken sourcing was margin accretive (by 20 bps) and partially offset the higher year-over-year cost of avocados and beef, which are not currently contracted.
  • CMG has not locked in cheese or sour cream. 

Howard Penney

Managing Director