Chipotle Mexican Grill Defies California Drought, Supply Issues

Joe Goldman |

Amid one of the worst droughts in history, agriculture supply on the west coast has been devastated. The drought has pummeled west coast farmland and sent agriculture prices for agricultural goods soaring higher – a severe burden on farmers, consumers, and restaurants.

Earlier this month, beef soared to an all-time high of $4 per retail pound as supply per person sank to a 60-year low. Meanwhile, avocado, lettuce, dairy product, tomato, and bell pepper prices have risen as well, and many agriculture experts anticipate that prices will continue to rise as the west coast struggles through a rainless summer.

Timothy Richards, an agribusiness professor at Arizona State University, believes that the drought could propel avocados and lettuce prices higher by 28% and 34%, respectively. Richards also believes that 10-20% of the total supply of certain crops could be lost. Consequently, he projects that avocados will rise 17 to 35 cents to $1.60 per avocado, while lettuce, peppers, and tomatoes could also be poised for double digit percentage price increases.

Chipotle’s Drought-Defying Quarter

Many feared that raw costs could devastate restaurant earnings, stalling the performance of restaurant growth stocks like Chipotle Mexican Grill’s (CMG) .  In defiance, the company delivered a shocking blockbuster quarter on Monday. Chipotle destroyed earnings and revenue estimates by delivering $3.50 EPS on $1.05 billion in sales. Analysts were expecting $3.09 in earnings on $990 million sales. Same-store sales increased a massive 17%, one of the best comparable sales figures in Chipotle’s history.

So how was Chipotle able to deliver such stellar results in one of the most difficult restaurant environments in years?                                                             

Chipotle initiated a price-hike in the second quarter to offset these raw costs. Logically, many expected this price increase would decrease demand, or at least sway customers to opt for cheaper menu options or avoid ordering guacamole or a drink. However, Chipotle’s quarter defied logic – it blew away estimates because it has positioned itself as the gold standard of fast food quality, a luxury on which consumers are willing to pay a premium now more than ever.

Chipotle’s resistance to costs can be partially accredited to its commitment to serving “food with integrity.” Chipotle commits itself to serving locally grown produce, sustainably raised food, grass-fed beef, and products without synthetic hormones. Due to supply problems, Chipotle was forced to import some grass-fed beef from Australia this quarter, a clear sign of its commitment to this program.

Thus, Chipotle has positioned itself in a way that enables it to raise prices without threatening demand, thanks to a tectonic shift toward healthier eating even in the fast-food industry. The economy is helping as well; real estate has rebounded, stock prices are up, and unemployment is down, giving consumers more disposable income to spend on luxuries like higher-quality fast food.

Fast Casual Remains a Strong Theme

Fast casual dining remains in a bull market, a prominent trend that clearly has staying power in a difficult restaurant environment. This theme was affirmed by earnings report from McDonald’s and Yum! Brands this week. McDonalds (MCD) stock traded down 2% on Tuesday as it missed earnings and sale estimates on flat comparable sales. Meanwhile, Yum (YUM) delivered a disappointing quarter as well on Monday, sending the stock down around 5%.

Given strength in Chipotle and weakness in McDonalds and Yum, it’s safe to assume that consumers remain more committed than ever to eating high-quality food, even if it means paying more. The California drought may have no end in sight, but Chipotle is in a unique position of power to pass higher raw costs on to its consumers.

Shares of Chipotle soared over 13% on Tuesday, reaching an all-time high of $667.90.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
CMG Chipotle Mexican Grill Inc. 368.06 1.69 0.46 1,600,270
YUM Yum! Brands Inc. 64.44 0.98 1.54 2,654,989
MCD McDonald\'s Corporation 119.92 0.67 0.56 4,059,907
KDC.H:PUR Kadywood Capital Corp. n/a n/a n/a 0

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