Chipotle Mexican Grill got off to a solid start in 2013, posting better-than-expected restaurant margins on easing food costs. Heading into the first quarter, analysts had anticipated restaurant margins of 25.4%, a 200-basis-point decline year over year due to elevated beef, dairy, and avocado costs as well as operating expense deleverage stemming from our 1% comparable-restaurant sales growth outlook.
The comp target (which factored in a 2-point hit for Leap Day and Easter calendar shifts and tougher weather-related comparisons) proved accurate , but dairy and avocado costs declined faster than anticipated, resulting in restaurant-level margins of 26.3%, 90 basis points ahead of our forecast. Additionally, general and administrative costs decreased 160 basis points as a percentage of sales due to stock-based compensation accounting changes, aiding a 50-basis-point increase in operating margins to 16.5%.
Despite the better-than-expected first-quarter profitability metrics, we believe margin expansion could prove more difficult over the next quarter or two. Management remains committed to holding the line on pricing over the near term and driving comp growth through marketing message changes and a wider catering rollout, though we don’t envision comps exceeding the underlying first-quarter run rate of 3% until later in the year.
Analysts continue to view Chipotle as one of the clear leaders in the rapidly expanding fast-casual restaurant category and remain confident that the company can outgrow the broader restaurant group for years to come. However, data from the National Restaurant Association and other trade groups support our view that smaller, privately held fast-casual chains are finding themselves with easier access to capital and attractive real estate options and are subsequently ramping up unit expansion plans.
Longer term, our base-case assumptions continue to forecast that annual restaurant openings across all concepts accelerate to approximately 200 units per year starting in 2015 (representing average annual unit growth of about 10%), aided by excess capacity in the commercial retail real estate market and further rollout of its lower-cost Model A concept. Analysts remain comfortable with the pricing power inherent in the Chipotle brand and believe the company can support mid-single-digit comp growth over a longer horizon (which puts total company growth in the low teens range over the next 10 years).
Despite increased competition, analysts remain comfortable with our outlook calling for restaurant margins pushing 30% and operating margins eventually exceeding 20% over the next 10 years through increased scale, though we concede it may not be a straight line in reaching these goals amid international and secondary concept investments. That being said, we believe current market prices assume much more aggressive unit growth and margin expansion expectations, which could disappoint as industry competitive pressures become more apparent.
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