The fast food sector faces headwinds from rising adoption of appetite-suppressing GLP-1 drugs, which may reduce food consumption, and from inflation, which is driving consumers to seek cheaper options.

Despite strong fundamentals, Chipotle Mexican Grill (CMG) saw an 8% stock drop after earnings due to narrowly missing revenue expectations, although it achieved solid revenue growth, improved operating margins, and resilience in consumer demand.

Chipotle remains focused on expansion, aiming for 7,000 restaurants in North America and continued global growth, but investors are cautious due to high market expectations.

Investor Essentials Daily:
Wednesdays News-based Update
Powered by Valens Research

We have been discussing the many headwinds currently impacting the fast food sector.

A recent survey found that one in eight U.S. adults (12%) admits to using glucagon-like peptide-1 (GLP-1) drugs.

GLP-1 drugs work by mimicking the effects of a naturally occurring hormone called glucagon-like peptide-1, which is released after eating and signals feelings of fullness.

These drugs slow the movement of food from the stomach into the small intestine, making people feel full faster and for longer durations so that they end up eating less.

This appetite-reducing and calorie-cutting effect is revolutionary for human physiology and will likely impact many businesses in the food industry over the long run.

By decreasing overall food consumption, wider adoption of GLP-1 drugs may gradually erode sales at restaurants, packaged food companies, and supermarkets.

Furthermore, The Federal Reserve has been aggressively raising interest rates to slow inflation, but Fed Chair Jerome Powell acknowledges that achieving the long-term 2% target will be challenging.

One of the clearest indicators of shifting consumer behavior comes from Amazon (AMZN). In a recent conference call, Amazon CEO Andy Jassy noted customers are increasingly looking for deals and trading down to less expensive products.

This trend of “trading down” is impacting many industries as inflation eats into household budgets.

The food industry in particular has been impacted negatively by inflation. Food prices rose nearly 10% in 2022, the highest rate since 1979. As the cost of dining out increases, consumers are trading for cheaper alternatives.

However, Chipotle Mexican Grill (CMG) has proven to be a different story, demonstrating resilience with steady revenue and income growth year over year.

Yet, even with its positive performance, Chipotle’s stock still fell 8% after its most recent earnings, a drop driven largely by unmet expectations rather than poor results.

In its latest earnings report, Chipotle posted a 13% year-over-year increase in revenue, totaling $2.97 billion.

While this is strong growth, it was shy of Wall Street’s estimates by about $30 million. This miss on revenue came despite a solid increase in comparable sales, which rose by 6.0% over the previous year.

Analysts had hoped for a slightly higher increase of 6.4%, but Chipotle’s growth was nevertheless supported by a blend of more transactions ‘’up 3.3%’’ and higher average checks ‘’up 2.7%’’.

Margins tell an interesting story for Chipotle this quarter. Operating income rose to 16.9% of sales, which is an improvement over last year’s 16.0% and beat analysts’ consensus of 15.7%.

However, restaurant-level margins fell slightly, down 80 basis points to 25.5% of sales. This dip in restaurant-level margins was mainly due to inflation in ingredient costs, specifically avocados and dairy.

Additionally, Chipotle focused on maintaining portion sizes and quality, which, while positive for customer satisfaction, increased costs.

The success of limited-time offerings like the Smoked Brisket also impacted the company’s protein mix, contributing to these mixed margin results.

Scott Boatwright, Chipotle’s interim CEO, highlighted the company’s focus on people, food quality, and efficiency in driving these results.

According to Boatwright, “Our focus on exceptional people, food, and throughput and the long-awaited return of Smoked Brisket drove another quarter of strong results.”

Boatwright also emphasized the company’s commitment to its long-term goal of reaching 7,000 restaurants in North America and expanding its brand globally.

For the remainder of the year, Chipotle projects comparable restaurant sales growth in the mid-to-high single digits.

Additionally, the company plans to open between 285 and 315 new restaurants, with over 80% of these featuring “Chipotlanes,” a drive-thru concept aimed at enhancing convenience for digital orders.

Looking forward to 2025, Chipotle anticipates opening between 315 and 345 new locations. This guidance, however, is slightly below what analysts had expected, as consensus had pointed toward 358 new openings.

Chipotle’s reaction in the market serves as an example of investing in companies with high expectations.

The company’s fundamentals remain solid, with consistent revenue growth and a strategy focused on long-term expansion.

However, the stock’s 8% drop following earnings highlights the market’s sensitivity to unmet expectations, even when the company itself is performing well.

Investors should be mindful of the risks associated with companies trading at high valuations and high expectations.

Best regards,

Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research