Higher food and legal costs are pressuring margins at Chipotle Mexican Grill, but officials at the fast-casual chain remain focused on growth opportunities ahead, including European expansion, the launch of a new concept and the possible addition of breakfast.
In a call to analysts Tuesday following its June 30-ended second quarter results, Chipotle officials upgraded estimates of food cost inflation for the year.
John Hartung, Chipotle’s chief financial officer, previously estimated food costs would increase by about 5 percent, but now officials are expecting it to reach about 7 percent for the year, largely because of the higher cost of avocados and beef.
However, menu price increases the chain began to implement in late June are expected to offset most, if not all, of the impact of food cost inflation on margins by the fourth quarter, when the higher price of avocados is expected to level off, Hartung said.
The amount of Chipotle’s menu price increases varies by market, but Hartung said it would be about 4.5 percent on average. About 80 percent of the 1,131-unit chain will see prices rise and the pricing rollout should be complete by August.
Chipotle has kept pricing steady over the past three years, although in the first quarter Chipotle also raised prices in its Pacific region units, where officials said pricing had not yet caught up with the rest of the system.
“Although it’s early, we’re encouraged that we’ve not seen any evidence of customer resistance from either of the price increases,” Hartung said.
Of the 10-percent increase in same-store sales reported for the quarter, about 1.5 percent was due to the menu price increase in Western states, but most was attributed to improved traffic, Hartung said.
The potential for increased labor costs also is a concern.
Monty Moran, Chipotle’s co-chief executive, said the chain has suffered a higher-than-usual turnover rate in recent months — particularly in April and May — a shift he suspects is tied to publicity about the U.S. Immigration and Customs Enforcement, or ICE, probe into hiring practices launched earlier this year. The ICE effort also sparked a criminal investigation by the U.S. Attorney’s Office.
Although turnover has moderated in the past month or so, Moran said it had reached about 120 percent. Typically, Chipotle has a turnover rate of about 100 percent, which is low compared with competitors with rates of 160 percent or more, he said.
“We’re feeling like it’s going to level off and return to normal,” Moran said.
There are no new developments in the ongoing criminal investigation, however, the chain reported $1.3 million in incremental legal costs during the quarter, mostly responding to requests for documentation, he said.
Since March Chipotle has been using the federal E-Verify system to verify eligibility of employment for job candidates and has since hired about 12,000 workers.
Moran said the move does not appear to have an adverse effect on Chipotle’s ability to attract top-quality applicants.
Following are more tidbits from the call to analysts:
• Breakfast: A Chipotle unit at Dulles International Airport in Washington offers breakfast, which Steve Ells, founder and chief executive, said was required by its lease there.
“Customers love it and breakfast sales are very strong,” he said.
“We think there is an opportunity at some point to add breakfast. How we do that and when, we’re not sure,” he said.
• Loyalty: The chain is rolling out its first affinity program, which it calls the “Farm Team.” Unlike most loyalty programs that reward frequent visits, Chipotle’s new initiative will reward guests for their knowledge and understanding of the chain’s Food With Integrity effort.
Farm Team members, for example, will be invited to learn where Chipotle’s ingredients come from, play games online and take quizzes based on the material to earn badges and points to exchange for free food and other prizes, Ells said.
Initially, store managers will invite the most loyal customers to become Farm Team members to create a passionate set of “evangelists,” he said. Eventually, the program will be expanded to include a broader range of guests.
• Growth: Chipotle’s first unit in Paris is scheduled to open in the third quarter along with a second London restaurant.
Chipotle’s second concept, dubbed ShopHouse Southeast Asian Kitchen, is scheduled to open in Washington, D.C., later this summer.
• People: Moran said Chipotle will accelerate the development of its “restaurateurs,” certain of the chain’s elite managers who have been trained to mentor crewmembers into general managers.
Moran said 60 percent of Chipotle units are overseen by restaurateurs or someone who has been through the program. In September, the chain will call a management meeting to discuss ways to speed up the process.
• Soul Daddy: Hartung said Chipotle lost $2.4 million, or 5 cents per share, from its investment in the Soul Daddy concept that won the television reality show competition, “America’s Next Great Restaurant.”
After opening in May, the three locations of the healthful soul food chain were closed by the end of June. “The three restaurants were running significant negative cash flow and had run through all the funding provided by investors, which included Chipotle,” Hartung said.
• Healthful ingredients: Chipotle is expanding the roll out of brown rice as an option, which Ells described as “very popular” among customers. The option is currently available in 140 units.