Chipotle Mexican Grill (CMG) is trading sharply lower this morning (-13%) after reporting disappointing Q3 earnings results last night. EPS came in at $0.69, net of a $0.64 impact from estimated charges recorded related to the data security incident and approximately $0.13 of impacts from Hurricanes Harvey and Irma. This was a good bit below market expectations. Revenue increased 8.8% to $1.13 billion, which was generally in-line. Comps increased +1.0%.
The benefit of menu price increases at select restaurants during Q2 and decreased paper cost and usage were offset by higher avocado and beef prices, as well as steak making up a higher portion of the product mix compared to 3Q16. Restaurant level operating margin was 16.1%, an improvement from 14.1% in 3Q16.
On the call, management talked about how Q3 saw the rollout of CMG's largest ever television advertising campaign, which was used to promote queso. Early indications are that it's driving sales at the start of Q4. CMG also drove sales through its ongoing efforts to strengthen digital ordering, which continues to perform near record levels. Since implementing Smarter Pickup Times earlier this year, the company has seen a 51% increase in digital orders.
Management noted that Q3 was very unusual due to hurricanes that prompted the closure of hundreds of restaurants across three states, and the costs associated with the data security issue seen earlier in the year. In spite of these challenges, CMG says it closed the quarter on a positive note, with sales trends that it hopes will continue during Q4. Year-to-date, comps are +8.3%.
CMG is working on a variety of initiatives, including several new menu items, which include frozen margaritas, desserts, new salad greens and dressings, and a range of other menu items which are currently in the R&D process. Its team is also designing a new beverage program for Chipotle, which includes a top to bottom redesign of the beverages it serves.
During the quarter, CMG launched queso nationally. The launch followed a large-scale consumer test in more than 350 restaurants, during which the company experienced encouraging sales and research results. Unlike nearly every other fast food company, Chipotle rarely adds new menu items, so the addition of anything new generates significant interest, positive and negative. Nevertheless, CMG says results show that many of its customers enjoy its queso made with no preservatives or artificial ingredients, and it was an easy decision to roll it out nationally.
With the national queso launch, CMG saw an immediate sales lift in the high single-digits as a percentage, which leveled off after initial trial. Currently, about 15% of customers continue to order queso. This new menu item not only increased sales with existing customers, it also attracted new and lapsed customers into its restaurants.
CMG opened 38 new restaurants during the quarter, closed two restaurants, and relocated one restaurant, bringing the total restaurant count to 2,374. CMG expects to open 130-150 restaurants next year, a reduction from this year's openings. While CMG still firmly believes that it has the potential to open up 5,000 restaurants in the US, the company has decided that it is a higher priority right now to focus on operational excellence.
In sum, investors are clearly pretty disappointed with CMG's Q3 results. Certainly the hurricanes had an impact but it also seems that CMG has not fully recovered from those highly publicized foodborne illness incidents last year. That could still take some time. The good news is that CMG sounded pretty optimistic about the early results in Q4.