Chipotle Makes Slow Comeback After E.Coli Scare

Burrito chain’s Q4 FY16 net income nosedived to $16.0 million from $67.9 million

Chipotle Mexican Grill Inc. (NYSE: CMG) announced its Q4 FY16 and full-year FY16 financial results on February 02nd, 2017.

The Denver, Colorado-based company, together with its subsidiaries, operates Chipotle Mexican Grill restaurants. The Company’s Chipotle Mexican Grill restaurants serve a menu of burritos, tacos, burrito bowls, and salads. The Company operates approximately 1,970 Chipotle restaurants in the US, over 10 in Canada, 7 in England, 4 in France and 1 in Germany. The Company’s restaurants include over 10 ShopHouse Southeast Asian Kitchen restaurants, serving Asian-inspired cuisine. The Company owned and operated approximately three Pizzeria Locale restaurants, a fast casual pizza concept. As of December 31st, 2016, the company operated 2,250 restaurants.

The Company categorizes its restaurants as end-caps (at the end of a line of retail outlets), in-lines (in a line of retail outlets) and free-standing, among others. The Company has about 1,230 end-cap locations, about 330 free-standing units, roughly 310 in-line locations and 130 other locations. The Company’s average restaurant size is over 2,530 square feet and seats over 60 people. Read more about Chipotle’s financial results below.

Q4 FY16 financial highlights

During Q4 FY16, Chipotle’s revenue grew 3.7% to $1.03 billion versus $0.99 billion in the year-ago same period. The increase in revenue was driven by new restaurant openings, partially offset by a 4.8% decrease in comparable restaurant sales. Comparable restaurant sales declined due to a fall in the number of restaurant transactions, and to a lesser extent from a decline in average check. Comparable restaurant sales decreased 20.2% in October 2016, 1.4% in November 2016, but increased 14.7% in December 2016. Comparable restaurant sales benefitted from easier comparisons due to lower sales in November 2016 and December 2015. Chipotle opened 72 new restaurants during the quarter, bringing the total restaurant count to 2,250.

During Q4 FY16, Chipotle’s food costs accounted for 35.3% of revenue, an increase of 150 basis points compared to Q4 FY15, driven by higher avocado prices and increased expense for pre-diced tomatoes, partially offset by relief in beef prices. Restaurant level operating margin was 13.5% in the quarter, a decrease from 19.6% in the year-ago comparable period, mainly due to higher marketing and promotional spend, sales deleveraging and higher food costs.

Moreover, general and administrative expenses were 6.3% of revenue for the reporting quarter, an increase of 160 basis points over the year-ago period. In dollar terms, general, and administrative expenses increased due to higher stock-based compensation and legal expenses, partially offset by lower bonus expense.

As a result of higher costs, Q4 FY16 net income nosedived to $16.0 million, or $0.55 per diluted share, compared to $67.9 million, or $2.17per diluted share, in the year earlier same period.

FY16 financial highlights

During FY16, Chipotle’s revenue fell 13.3% to $3.9 billion due to a 20.4% decrease in comparable restaurant sales, which was partially offset by revenue from new restaurants. Comparable restaurant sales declined primarily as a result of a decrease in the number of transactions in our restaurants, and to a lesser extent from a decline in average check. Chipotle opened 240 new restaurants during the full year 2016, net of 3 relocations or closures, bringing the total restaurant count to 2,250.

Food costs were 35.0% of revenue, an increase of 160 basis points compared to the prior year, mainly due to increased waste and costs related to new food safety procedures as well as higher avocado prices, partially offset by relief in beef prices and a benefit of menu price increases implemented in select restaurants in H2 FY15.

During FY16, Chipotle’s restaurant level operating margin was 12.8% for the full year 2016, a decrease from 26.1% from the prior year, mainly due to sales deleverage, increased marketing and promotional spending, and other increased costs of doing business.

During FY16, Chipotle’s general and administrative expenses were 7.1% of revenue, an increase of 150 basis points over the prior year, primarily as a result of sales deleverage. In dollar terms, general and administrative costs increased compared to the prior year due to higher legal expenses and higher payroll costs, partially offset by lower bonus expense and travel costs.

Moreover, the 2016 effective tax rate was 40.8%, an increase of 2.6% from 2015, due to higher state tax rates, not qualifying for the federal research and development tax credit in 2016, and non-deductible items on overall lower pre-tax operating income. As a result, net income for the full year FY16 plunged to $22.9 million, or $0.77 per diluted share, compared to net income of $475.6 million, or $15.10 per diluted share, for the prior year.

Other highlights

Restaurant openings: During Q4 FY16, Chipotle opened 72 new restaurants. It opened 240 new restaurants, net of 3 relocations or closures in FY16. Chipotle plans to open 195-210 new restaurants in FY17, less than the 240 opened in 2016.

Spending on comeback strategy: Chipotle has struggled to regain its footing after a series of food safety scares and E.coli breakout in 2015, and the recent arrest of one of its executives for drug possession. As its business slowly climbs back to normalcy, Chipotle has been aggressively trying to woo customers and restore customer trust with promotional offers, discounts and coupons.

Steve Ells, Founder, Chairman and CEO of Chipotle, stated:

“Our entire company is focused on restoring customer trust and reestablishing customer frequency. In the upcoming year, we intend to continue to simplify and improve our restaurant operations, utilize creative marketing to rebuild our brand, and further the roll-out of our digital sales efforts. All three of these strategic initiatives are centered on improving the guest experience and restoring customer affinity for the Chipotle brand, and we are confident in our teams’ abilities as we start this New Year.”

Chipotle has employed an expansive comeback strategy, including using coupons, promotional discounts and even a short animated film about the perils of big food operations to get customers back buying burritos again. It implemented new food safety standards and shook up its long-unchanged menu with a new item: chorizo, a spicy chicken and pork sausage available in select locations. Chipotle is also investing in expanding digital ordering. Management said it will have a new catering and online ordering platform fully rolled out in early February 2017, and that this would drive up labor costs as a percent of sales in Q1 FY17. The company is also in the early stages of planning for a massive advertising campaign, which will begin in April 2017.

Chipotle plans to open 195 to 210 new restaurants this year, less than the 240 opened in 2016. This is an intentional reduction, as management has been conservative with capital allocation, and will continue to use cash from operations to finance growth, maintaining the current $543 million in cash and liquid investments as a margin of safety.

Guidance for FY17

For 2017, management is targeting comparable restaurant sales increases in the high-single digits with 195 to 210 new restaurant openings. An estimated effective full year tax rate is predicted to be between 39.0% and 39.5%, which will be impacted by volatility due to a recently issued accounting standard that changes accounting methods for taxes associated with stock-based compensation awards.

Stock Performance

Chipotle’s stock ended the day at $414.14, gaining 0.19%, at the close on Monday, February 13th, 2017, having vacillated between an intraday high of $419.47 and a low of $413.55 during the session. The stock’s trading volume was at 586,593 for the day. The Company’s market cap was at $11.97 billion as of Monday’s close.

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