Industry News | August 28, 2017 | QSR Exclusive Brief

Soaring Avocado Prices Deal Another Blow to Chipotle

Chipotle continues to battle back from its 2015 food safety crisis. flickr: Mike Mozart
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Back in July, Chipotle expressed optimism concerning its strained relationship with avocados. Chief financial officer John R. Hartung said following the chain’s second-quarter earnings that higher avocado costs were masking other cost-savings initiatives. Food costs grew from 33.8 to 34.1 percent from the first quarter, or 30 basis points, thanks to the key guacamole ingredient. However, Hartung said Chipotle was starting to see some relief, and with “help from normalizing avocado prices,” margins could creep back to the 20 percent target range the brand set the previous year.

No such luck.

Since July, avocado prices have spiked a staggering 75 percent. Credit Suisse analyst Jason West said supply shortages in Mexico and a weaker-than-expected California harvest are to blame. He lowered Chipotle’s target stock price to $320 from $335 as a result.

This reality has fattened the pockets of short sellers, or those who borrow shares to bet against a stock, around the country. Financial-analytics firm S3 Partners reports that short sellers have made $467 million betting against Chipotle in the third quarter alone.

The avocado inflation is undeniably concerning news for Chipotle, which reported food costs as 34.1 percent of revenue in the second quarter. That decrease of 10 basis points compared to the second quarter of 2016 showed higher avocado costs offset by lower costs “from bringing the preparation of lettuce and bell peppers back into our restaurants, as well as the benefit of menu price increases in select restaurants in the second quarter of 2017, and a decrease in paper usage and costs,” Chipotle said.

Year-over-year, avocado prices are now up nearly 50 percent, Credit Suisse said. West and fellow analyst Jordy Winslow estimate that avocados make up nearly 10 percent of Chipotle’s cost of goods sold.

They believe that a 10 percent increase in avocado prices impacts Chipotle’s margins by 30 basis points and earnings per share by about 30 cents.

This is a very unwelcomed departure from executives’ hope for avocado price moderation in the back half of fiscal 2017 and beyond. Instead, prices could rise 10 percent and 25 percent in the coming two quarters, per Credit Suisse. The effect: 25 cents off third-quarter earnings per share estimates and 35 cents in the fourth quarter.

The bad news is yet another dent in Chipotle’s progress following 2015’s food safety crisis that erased around half of Chipotle’s market cap. Shares have declined more than 35 percent in the past three months, and hit their lowest level in more than four years August 22 at $304, the lowest since February 6, 2013. Chipotle was trading at $309 midday Monday.

Chipotle’s same-store sales have trended positive this year, with comps increasing 8.1 percent in the second quarter, year-over-year, and 17.8 percent in the first. But then came another food safety scare, as a Sterling, Virginia, restaurant closed for two days following reports of norovirus. More than 130 customers claimed to have fallen ill from eating at the restaurant. Chipotle said the incident was isolated and resulted from a sick employee coming to work and not following protocol. A restaurant in the Dallas area was also closed after a video of rodents running around the store surfaced. Chipotle credited the issue to a structural gap in the 100-year-old building.

Chipotle has some initiatives coming down the pipeline, including its queso tests and first drive thru, as well as some other menu rollouts. The brand also hired its first communications officer in Laurie Schalow, who previously held a variety of positions at YUM! Brands.