WWith inflation at its highest levels in several decades, many companies are grappling with rising input costs affecting their bottom line. This is especially true for companies that have high costs for food and energy and a large number of employees.
Fast-food chain of Mexican restaurants Chipotle (NYSE: CMG) Fits this description perfectly. With nearly 100,000 employees seeing their wages rise and food costs rising (avocados aren’t cheap!), the company’s store-wide margins are moving in the wrong direction, leaving investors anxious about its outlook in the coming quarters.
Chipotle is clearly struggling with inflation at the moment, and shares are down 27% since the start of the year. So is the stock still a buy for long-term investors?
The first quarter looked solid
In the first quarter of 2022, Chipotle’s revenue grew 16% year over year to $2 billion. This was driven by 9% growth in comparable store sales and the opening of new restaurants. Operating margin was 9.4% in the period, up from 9.3% a year ago.
Chipotle is experiencing store-wide inflationary pressures right now, with food and labor costs accounting for 31% of revenue, up 100 basis points year over year. But so far, the company has been able to showcase its pricing ability to relieve a lot of these cost pressures.
The only concern is operating margin at the Chipotle store level. In the first quarter, that metric was 20.7%, down from 22.7% a year earlier. So far, the company has been able to maintain standard operating margin through company-wide operating leverage.
But if Chipotle is to reach the operating margins they were before the E-coli outbreak (which was north of 15%), store-wide operating margins will likely need to rise in the coming years. Inflation can prevent this from happening.
Long-term opportunities still exist
We will return to profit margins in the next section. But first, let’s talk about Chipotle’s opportunity to increase the number of its stores in its native North American markets (US and Canada). The Mexican food chain currently has just over 3,000 restaurants, a total that has steadily increased each year since its initial public offering (IPO) in 2006.
In the long term, management believes Chipotle could reach 7,000 locations in North America alone, or about 2.3 times the number of current stores. If businesses continue to grow while the number of stores grows at this multiplier, then Chipotle’s 12-month delayed revenue of $7.8 billion could grow at multiples of 3 or maybe even increase this decade. This represents a great deal of impetus for a casual restaurant chain, and this is before considering the company’s early steps to enter the European market.
Margins will determine Chipotle’s fate
If Chipotle can grow its number of stores to 7,000 and triple its revenue by 2030, it will generate $23.4 billion in annual revenue by then. This might make you think the stock is a buy, but we need to cut the income statement and assess profit margins by then.
Assuming Chipotle is able to restore its old form and expand its margins to 15% by 2030, the company will earn $3.5 billion in annual operating income. At a current market capitalization of $35 billion, that would give the stock a forward price to operating income (P/OI) ratio of 10.
But if inflationary pressures kept margins closer to 11% (where they are now), operating income would be just $2.57 billion in 2030, at a forward P/OI of 13.6. This may not seem like a big change, but it could be the difference between Chipotle winning or tracking market returns over that time period.
Predicting inflation in 2030 and how it will affect Chipotle’s profitability would likely be a fool’s errand. But it may be helpful for investors to look at these different scenarios to see what the different margin levels will do to Chipotle’s potential as a stock.
If you own stock, you need to be confident that the company can continue to expand profit margins through efficiency gains and pricing power in the next decade.
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Brett Schaeffer has no position in any of the mentioned stocks. Motley Fool has positions at and recommends Chipotle Mexican Grill. Motley Fool has a disclosure policy.
The opinions and opinions expressed here are those of the author and do not necessarily reflect the views and opinions of Nasdaq, Inc.