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Quick-casual restaurant chain, Chipotle Mexican Grill Inc.’s (CMG - Analyst Report) third-quarter 2013 earnings of $2.66 per share missed the Zacks Consensus Estimate of $2.77 by nearly 4% due to lower margin and increased costs. However, earnings were up 17.2% year over year, led by higher top line.

Revenues grew 18.0% year over year to $826.9 million and also beat the Zacks Consensus Estimate of $818 million by 1.1%. The better-than-expected results were backed by higher comparable sales (comps) growth and unit expansion.

Behind the Headline Numbers

Comps grew 6.2% during the quarter led by higher traffic. Comps increased 70 basis points (bps) sequentially and 140 bps year over year.

The restaurant level operating margin was down 60 bps annually to 26.8% in the reported quarter. Higher food costs and mounting marketing expenses offset lower labor cost and pressurized the margin.

Food, beverage and packaging costs as a percentage of revenues increased 100 bps to 33.6% with the rise in costs for salsa ingredients such as tomatoes, corn and tomatillos and higher dairy as well as chicken prices. Moreover, since the company is now using non-GMO (genetically modified organism) sunflower and rice bran oils instead of GMO soy oil, oil costs have increased leading to higher food costs.

Labor costs as a percentage of revenues contracted 40 bps to 22.8% as a result of the higher comps. Total operating margin, however, declined 20 bps to 16.6% in the quarter due to higher operating costs.

Stores Update

During the third quarter, Chipotle unveiled 37 restaurants. As of Sep 30, 2013, the company operated 1,539 restaurants. The company has also introduced a new ShopHouse restaurant in Washington, DC in the quarter. During the quarter, the restaurateur debuted in Frankfurt, Germany. Chipotle now operates 14 restaurants internationally.

Further, the company remains on track to open nearly 165–180 restaurants this year. Apart from this, the company also intends to unveil more ShopHouse units by 2014.

Liquidity

Chipotle ended the quarter with cash and cash equivalents of $308.1 million versus $$281.6 million in the previous quarter. Total shareholder equity was consistent at $1.47 billion.

Share Repurchase

In the third quarter, the company bought back 41,000 shares worth $17 million and nearly $103 million worth of shares are left to be purchased under the company’s existing share repurchase program. 

Guidance

The company has increased its comps guidance for 2013. Following the improving traffic trend, management now expects comps to grow in mid single-digits, higher from the previous estimate of low-to-mid single digits.

For 2014, Chipotle will open 80 – 195 restaurants. The company expects low single-digit comps growth for 2014.

Our Take

Though Chipotle missed earnings estimates, we are encouraged by double-digit top-line growth and higher comps. We believe that the company’s initiative to provide GMO-free foods will trigger its business in the ensuing quarters.

Though lower margin remains a concern, overall, we are encouraged by Chipotle’s strong market standing, new menu launches and increased media exposure. We believe that the Zacks Rank #2 (Buy) company has compelling growth drivers like the ShopHouse concept and catering program to sustain revenue momentum, going forward.

Some other players in the restaurant industry which look attractive at the current level include Red Robin Gourmet Burgers Inc. (RRGB - Analyst Report), AFC Enterprises Inc. and Bob Evans Farms, Inc. (BOBE - Snapshot Report). While Red Robin holds a Zacks Rank #1 (Strong Buy), AFC Enterprises and Bob Evans Farms carry a Zacks Rank #2.

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