Inflation Bites Chipotle Mexican Grill Inc.'s Earnings. Here's How It's Going to Bite Back

By Markets Fool.com

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Chipotle has seen these swings in investor sentiment before and should prove able to withstand them once again.

What have you done for me lately, Chipotle Mexican Grill ? That's the question investors seem to be asking the Mexican food chain after selling off its stock by 10% following the blowout numbers it recorded in its fourth quarter earnings report.

Because the stock market remains a forward-looking machine, investors were seemingly spooked by Chipotle's moderate projections for same restaurant sales growth as it laps the double-digit gains of 2014 and sky-high beef prices continue to take a toll. Management was only able to forecast low- to mid-single-digit comps growth for 2015 as it contemplates imposing a surcharge on its beef and barbacoa dishes to cover those rising costs.

Riding herd on beef prices
Although Chipotle was able to pass along a hefty 6.3% price increase last year without any apparent blowback from customers -- its comps jumped 16% in the fourth quarter regardless -- the Mexican-food restaurant was hit by even heftier 7.5% food inflation so its price hikes didn't cover the full cost. The company estimated, however, that inflation hikes swiped about 1% in its traffic growth.

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Rising beef prices have taken a bite out of Chipotle's barbacoa dishes. Photo: Chipotle Mexican Grill

That's partly why Chipotle doesn't want to impose a second round of price increases right away. It also admits it's still earning record profits and margins so instead of across-the-board hikes, it's considering a surcharge just on its beef dishes if prices remain in the stratosphere. What the Mexican food chain calls "food with integrity" also implies it should be able to charge a fair price for the ingredients it uses.

Beef prices are expected to remain elevated throughout 2015 and into 2016 due to continued supply constraints, and that's why Chipotle is considering the surcharge, or what it refers to as a "targeted price increase" on just the beef dishes. But while Chipotle's menu price increases helped boost its average check 8.5% during the third quarter, there are only so many times diners can be squeezed by rising prices.

Chipotle does benefit from public perception that it is fully committed to ethically sourced ingredients, but having to continuously pay up may cause customers to pick cheaper dishes instead, or worse, head to competitors. Both outcomes could hurt profits.

When it rains, it pours

Sometimes being ethical means hardship, but its customers benefit in the end. Photo: Chipotle Mexican Grill

The hike in beef prices comes as the restaurant continues to deal with a pork shortage at hundreds of its locations due to suspending a supplier for failing to meet its animal welfare standards, and Chipotle Mexican Grill could end up having a full-blown crisis similar to last year's "guacalypse" that followed an avocado shortage.

To minimize the effects of shrinking carnitas availability, the chain is rotating the restaurants that don't receive pork so that no one area will be without the dish for any length of time. It's still too early to say what sort of impact it will have on first quarter results, but certainly the public will appreciate its efforts at openness and transparency. It could have supplemented its supply with conventionally raised pigs, but that violates its own ethical compass.

The cost of doing the right thing is worth it
By adhering to its internal integrity, Chipotle Mexican Grill has separated itselffrom other quick-serve restaurants. It's probably why its customers didn't abandon it in the face of higher prices last year. A targeted increase affecting only those dishes that are being subjected to market forces beyond Chipotle's control will cement that view the restaurant cares about its customers.

Ultimately, Chipotle's stock sell-off seems overdone, though it also appears to be something of a recurring pattern. After its third quarter results, for example, where it noted the looming comps hurdle it would have to get over, Chipotle's stock sharply dropped 7%. Of course, it rebounded to record new all-time highs and ended up peaking at $680 last Thursday, but investors might not expect Chipotle to repeat that performance.

Right on cue, the Mexican food chain's stock is starting to bounce back as investors realize the fears of impending doom are probably overblown. At 47 times earnings and 32 times estimates, Chipotle Mexican Grill isn't cheap by most common standards, but it's an uncommon company and that should let it bite back at the inflation that would otherwise sink a lesser chain.

The article Inflation Bites Chipotle Mexican Grill Inc.'s Earnings. Here's How It's Going to Bite Back originally appeared on Fool.com.

FollowRich Duprey's coverage of all therestaurant industry'smost important news and developments. Hehas no position in any stocks mentioned.The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.