Chipotle Faces Challenges as Leadership Changes Begin

The post-Brian Niccol era is underway at Chipotle Mexican Grill(NYSE: CMG), and it’s off to an inauspicious start.

Shares of the burrito chain are down about 8% since the company missed top-line estimates and reported its slowest earnings growth in more than two years.

Chipotle posted same-store sales growth of 6%, which contributed to revenue’s 13% rise to $2.79 billion, though that fell short of the analyst consensus at $2.82 billion.

Further down the income statement, its restaurant-level operating margin fell from 26.3% to 25.5% as food costs rose due to higher prices for avocados and dairy. Management also said it used more ingredients due to efforts to ensure “consistent and generous portions.”

However, the company saved money in stock-based compensation expense due to Niccol’s departure, and operating margin increased from 16.0% to 16.9%, leading earnings per share up 17% to $0.28. That topped the consensus estimate at $0.25, but it was also the company’s slowest earnings growth in the last two years.

With Niccol now at Starbucks, Chipotle is at a pivotal moment. Let’s take a look at three questions management needs to answer for investors.

Image source: Chipotle.

1. Will Scott Boatwright be the permanent CEO?

Niccol announced his departure more than two months ago and officially left for Starbucks in September.

Chipotle and its investors were clearly surprised by the move, and the company promoted Chief Operating Officer Scott Boatwright to interim CEO.

The future of Chipotle’s leadership is still unclear, but investors deserve some clarity on the situation, at the very least by the next earnings report.

Keeping Boatwright on as the permanent CEO would seem to make sense based on the company’s success under Niccol, as he’s likely the best prepared to carry on that legacy.

The company previously said, “Boatwright played a critical role as part of the leadership team that created and executed the turnaround strategy,” and he “will continue to execute the company’s strategic plan without interruption.”

While there’s a clear blueprint for Chipotle’s growth, whoever the next CEO is will have to put their own imprint on the company as well, and Chipotle’s board should make that decision sooner rather than later.

2. How high can the restaurant-level operating margin go?

Chipotle is a straightforward business, and there are only a few key drivers to its performance. The company has to open new restaurants, grow same-store sales, and, ideally, expand its margins.

Of all its margins, the restaurant-level operating margin is the most important, as it subtracts food, labor, rent, and other direct operating costs from revenue.

Chipotle had been steadily growing this margin, but it hit a wall in the third quarter as it fell from 26.3% to 25.5%. The company has never given a target for this margin, but investors have assumed it can continue to trend upward, especially alongside growing same-store sales.

As Chipotle operates in the restaurant sector, there is a limit to how high this metric can rise, unlike in technology sectors. Currently, with the stock trading at a price-to-earnings ratio of nearly 55, investors seem to be counting on continued margin expansion, and they could use some clarity from management on what the long-term expectations are.

3. Are there better options for its capital?

Chipotle is now spending most of its profits on share buybacks, but this strategy is questionable given the high valuation.

Past efforts to launch new brands, including ShopHouse, Pizzeria Locale, Tasty Burger, and Farmesa, have all failed. However, there are still opportunities for Chipotle, such as investing in existing restaurant chains or technology that could transform operations.

Chipotle also seems mature enough to pay a dividend, yet it hasn’t done so. Implementing a dividend could complement the share repurchase program.

Ultimately, the company’s capital deployment strategy will be an important focus for the incoming CEO.

Should investors consider Chipotle as a buy?

Chipotle remains a solid business, but its premium valuation, leadership uncertainty, and slowing bottom-line growth warrant caution.

The company aims to open 7,000 restaurants in North America, which would nearly double its current presence. This goal necessitates strong comparable sales growth for the stock to perform well moving forward.

Given its strong position in the fast-casual dining sector, Chipotle could still be a worthy long-term investment. However, investors are advised to seek more clarity from management regarding the raised questions—and perhaps a more favorable share price—before making a buying decision.

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Jeremy Bowman has positions in Chipotle Mexican Grill and Starbucks. The Motley Fool has positions in and recommends Chipotle Mexican Grill and Starbucks. The Motley Fool recommends the following options: short December 2024 $54 puts on Chipotle Mexican Grill. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.