Burrito Bust: Why Chipotle Profits Are Hurting

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Source: Getty Images

Source: Getty Images

Upon the release of Chipotle Mexican Grill’s (NYSE:CMG) first-quarter earnings, shares spiked as high as $588/share after closing on Wednesday at $552/share. However, as reality set in during the day, the stock began to slump — shares closed near the day’s low of just under $520/share.

To readers of my March 31 article on Chipotle, this weakness should have come as no surprise. In that piece, I suggested that the shares were grossly overvalued at $567/share, and that the company was vulnerable to several risk factors, including one that hit margins in the Q1 report — rising food prices.

Investors initially bid up shares of Chipotle because of its strong revenue growth — 24 percent year-over-year. This is a growth rate that is virtually unparalleled, and it is one of the reasons that investors are willing to pay such a high P/E multiple — 42 — for Chipotle shares. However, profits grew at just 8.5 percent, which is completely unacceptable for a company trading at such a high multiple to earnings. Furthermore, profits fell short of analyst estimates, coming in at $2.64/share versus an estimate of $2.86/share.

The reason for the unimpressive profit growth was margin compression due to an increase in executive compensation and rising food prices. The two combined to hit margins by about 280 basis points, which is devastating for a company that had just 10 percent profit margins in Q1 of 2013.

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