Chipotle Mexican Grill Class A Earnings Call Insights: Food / Cost Ratio and Restaurant Margins Outlook

Chipotle Mexican Grill, Inc. Class A (NYSE:CMG) recently reported its second quarter earnings and discussed the following topics in its earnings conference call.

Food / Cost Ratio

David Tarantino – Robert W. Baird & Co.: Jack, just a question on your pricing philosophy and strategy. I know you mentioned you don’t have plans to raise prices for the rest of the year, yet the food/cost ratio you mentioned also is going to creep up or stay similar to where it was in the first half which is above the historical norms. So, I am just wondering kind of how you are thinking about that. Is this another delay in your price increase or are you thinking that you don’t need it at this point. Maybe if you could just kind of layout your thoughts there?

John R. Hartung – CFO: Yeah, David I would. I’d call it a delay, but I think it’s a delay right now that based on what we see for the rest of this year. We don’t feel compelled to increase prices in the next two quarters. Certainly, that may change but based on our current margins, based on what appears to be a tamer food inflation environment generally, based on the fact that even the pressure I talked about mostly coming from avocados on our food cost line in the next couple of quarters, those are more cyclical than inflationary. I would argue that’s based on just what we’re seeing in California and Mexico and Avocados this year so they don’t feel like permanent inflationary items. And then another consideration is Steve had mentioned, we want to remove GMOs and that’s a significant challenge. There is going to be some cost associated with that as well. So, we like to be patient with that as well and so when we do raise prices, we may be able to time that when we are doing food integrity items like removing the rest of the GMOs in some of our ingredients. We also had some of our supply of naturally raised meat such as – stake this year will be a real challenge. We are working to get that back up 100. So, there is other 100, so there is things like that, that we think will add to the quality of our food but will may add to the cost as well and so, we think that it’s wise to wait until we understand what those costs are going to be and maybe time it around some of those items until. Right now, we don’t think we need to do anything in the next two quarters.

David Tarantino – Robert W. Baird & Co.: Jack, just to clarify some of the items you just mentioned, are those items you expect to happen early in 2014 and is that way your rating is just maybe a couple of quarters out from where you?

John R. Hartung – CFO: We hope so, David, but it’s hard to pin it out because when we’re changing ingredients like this, there are some many things to consider. Of course, cost is really just one of them. The most important is what’s the impact on the recipes is, what’s the impact on the taste of our food, the quality of our food. We want to be very careful before we’re switching out ingredients that we don’t have unintended consequences or we don’t have customers that feel like gee I don’t really like the taste, we don’t think that will happen, but we have to be very careful as we do this. So, it’s not unreasonable to think that we can get a lot of this done, maybe all of it done in the next two quarters, but it’s hard to say that with certainty.

Restaurant Margins Outlook

Michael Kelter – Goldman Sachs: I want to ask after your restaurant margins have gone up year after year after year for so many years. They stabilize now in this 26%, 27% range for the past three or four years, is there any reason to believe with some of natural ceiling about what the concept will be able to achieve? Or do you think maybe this is just a pause and you have a vision that it can move higher?

John R. Hartung – CFO: Michael, it can move higher, I don’t think it’s a natural ceiling. I think it depends on what our ultimate volumes are and that depends on what our comps are. We’ve always talked about that food cost aside, and food cost by the way the margin pressure we’ve seen in the quarter and for the year can be easily remedied by increasing prices, we think we’ve got that pricing power, we think our food cost is higher than it normally would be and so that part we think we can sell. So then beyond that, we think we still have leverage, if we can deliver a comp that’s at or above a mid-single digit comp, that is driven by transaction, we think we still can maintain or even add to our margins. In fact, we think that if we were able to drive a higher than mid-single digit comp we can increase our margins at a similar level to any other concept that’s at a much lower level. So, we don’t think our ability to raise margins has been diminished at all, but it all will depend on what the comps and what our ultimate average volumes end up being.

Michael Kelter – Goldman Sachs: And then do you have maybe any research that suggest the majority of your customers want to pay more for GMO free foods or is that a decision that you make more based on field?

John R. Hartung – CFO: Customers don’t fully understand GMOs. There is a small number of people and we’ve seen this when we recently put information about GMOs on our website that are really into it, really understand it and are really excited about us removing GMOs. I would say the vast majority of our customers are largely unaware of which of their foods that they eat everyday contain GMOs, what the impact of GMOs might be. There is a lot of debate and uncertainty around the real impact of GMO. So, we don’t necessarily think that customers are going to want to pay more or going to visit more often but all along the way on our food integrity journey we’ve always done things that we thought were the right things to increase the quality of the food that was going to be more wholesome, more helpful and won’t more of a (indiscernible) to the environment and we think GMOs follows along that same thinking. We think over time as our customers and as customers, in general, as they discover more about where their food comes from and as they discover more about what Chipotle is doing to source these higher quality ingredients we think that does build customer loyalty. So, we think it is going to be good for our business, Michael, but it is hard to say that there is a direct correlation between removing GMOs and people paying more or people visiting more.

Michael Kelter – Goldman Sachs: And if I could sneak in one last one. Since the employer mandate in the Affordable Care Act is delayed by year to Jan of 15, do you plan to hold-off on offering insurance to your employees until then?

John R. Hartung – CFO: We are still studying that. That is a very possible outcome. The one challenge we’re dealing with Michael is we’ve been offering for a number of years now a streamline version that our crew have had the option to elect and then pay for this coverage themselves, it’s called the Starbridge program. We’re trying to figure out whether we will be allowed to continue to offer that. Right now, it’s possible that we won’t be able to, that we’ll have to remove that. So, we don’t know how exactly to deal with our few thousand employees that are reelecting that, we’d like to not have to take something like that away from them. So, we’re still studying that. Right now, it’s likely that we will delay it, but this is the one issue that we want to get our arms around before we make a final decision.

A Closer Look: Chipotle Mexican Grill Earnings Cheat Sheet>>

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