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Sales Deleverage Caused Chipotle’s 1Q16 EBIT Margins to Fall

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Apr. 29 2016, Updated 11:07 a.m. ET

EBIT margins

Chipotle Mexican Grill (CMG) posted EBIT (earnings before interest and tax) of -$46.6 million. It represented EBIT margins of -5.6%—compared to 18.5% in 1Q15. Analysts were expecting the margins to be -6.2%.

The decline in EBIT margins was largely due to sales deleverage caused by same-store sales growth of -29.7%. A decline in same-store sales growth decreases revenue without reducing the capital expenditure.

Sales Deleverage Leads Chipotle's 1Q16 EBIT Margins to Decline

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Increased expenses

Apart from sales deleverage, EBIT margins also declined due to an increase in expenses. In 1Q16, the company spent $55 million on a marketing and promotional campaign. It was 6.6% of total sales and 5% more than 1Q15. The labor expenses were 8.5% higher than 1Q15 at 30.9% of the total sales. The increase in labor expenses was due to increased requirements during promotional events. This is non-recurring. Also, increased labor expenses due to more labor benefits increased the expenses by 1.6%. Compared to 1Q15, food costs were higher by 1.4% at 35.4%. The increase in food expenses was due to increased food rejection and enhanced food safety procedures. However, the decline in beef prices offset some of the decline. The general and administrative expenses rose by 1.6% due to sales deleverage.

Peer comparison

In 1Q16, Panera Bread (PNRA) and Brinker International (EAT) posted EBIT margins of 8.3% and 10.9%, respectively—compared to 9.3% and 12.1% in the same quarters in previous years. Analysts expect Shake Shack (SHAK) to post EBIT margins of 8.4% compared to 8.7% in 1Q16.

Outlook

The implementation of enhanced food safety procedures increased Chipotle’s expenses. Chipotle’s management claims that its enhance food safety procedures are the best in the industry. Analysts are predicting that the recovery in same-store sales growth will take time. So, with increased expenses and declining same-store sales growth, analysts are expecting the EBIT margins for 2016 to be 5.4%—compared to 17.3% in 2015. Chipotle forms 0.14% of the holdings of the iShares Russell 1000 Growth ETF (IWF).

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