Craig Warga/Bloomberg/Getty Images There have been plenty of laggards in the restaurant business this earnings season, but Chipotle Mexican Grill (CMG) hasn't been one. Winter storms that slowed business to most eateries in January and the more problematic trends gnawing away at eating out in general during the balance of the quarter just didn't apply to Chipotle. The rapidly expanding chains saw comparable-restaurant sales soar 13.4 percent during the first three months of the year, bucking against the negative showings at most of the casual dining, fast food and even quick-service operators that have already reported. This is the kind of development that the market would naturally interpret as good news, but Chipotle hasn't been as lucky. In fact, the country's favorite burrito roller saw its stock hit a three-month low to kick off this new trading week, fetching levels last seen in late January. Investors are getting skittish about what they're seeing on the way down to the bottom line at Chipotle, likely unaware that today's challenge is tomorrow's opportunity. Inflation Station From coffee to milk, shrimp to limes, many food items are a lot more expensive than they were a year ago. That's inflation rearing its ugly head. Chipotle isn't adding shrimp to its menu anytime soon, and it just started testing coffee at a couple of airport locations late last year. However, it has been at the mercy of other menu components moving higher lately. The fast casual darling singled out the escalating costs of beef, avocados and cheese for nibbling away at its margins during this year's first quarter. The margin contraction was evident in Chipotle's latest quarterly report. Revenue climbed 24.4 percent as the combination of brisk expansion and hearty comps fueled another top-line pop. Net income, on the other hand, only rose 8.5 percent when pitted against last year's freshman quarter. A big reason for less of Chipotle's sales making it down to the bottom line is inflation. Food costs as a percentage of revenue has gone from 33 percent a year ago to 34.5 percent now. Spoiler alert: it's going to get worse in the near term. Chipotle's targeting food costs to eat up more than 36 percent of its revenue in the next couple of quarters, forcing analysts to scale back their earnings estimates for the current quarter. Higher Prices Aren't the End of the World The inflation is real. Cheese prices are expected to climb 10 percent this year, and it's even worse on the beef side where Chipotle's paying 25 percent more for its steak than it was when the year began. Everything from farmland droughts to a 30 percent reduction in California avocado production will result in Chipotle paying more to serve you that next foil-wrapped barbacoa burrito with cheese and guacamole. Chipotle has swallowed the increases so far, but a response is now coming after Chipotle missed Wall Street's profit forecast during the first quarter. "With all of this food inflation we have seen so far and expect to continue to see, we've decided to increase our menu prices," Chipotle announced during its mid-April earnings call. This is Chipotle's first company-wide increase in three years. It has gradually adjusted prices in some markets as competitive pressures allowed in the past, but now it has little choice but to introduce new menu boards this summer with slightly higher prices. Customers won't like it, but they're not likely to complain. The beauty of running a popular restaurant at a time of food inflation is that patrons will actually see bigger increases if they simply eat at home. After all, if items at the grocery store to assemble your meal theoretically doubled in price you would be treated to a 100 percent increase. Since food costs are a little more than a third of Chipotle's sales, passing on those costs to consumers would be closer to a 35 percent increase to keep profits intact. This is an extreme illustration, of course. Only some components have been moving higher. Chipotle believes that the increase will average somewhere in the mid-single-digits. In short, that carnitas bowl will cost you a little more, but it's not likely to break the bank. That should come as a relief to Chipotle fans heading out to lunch once the new menu boards get updated this summer, but it should also come as an even bigger relief for investors that weren't rewarded for owning the stock during an otherwise impressive quarter.
