There’s an old joke that oddly fits one’s interpretation of Chipotle’s earnings results.
An old man sits on a train and moans loudly. “Oy, I’m thirsty, I’m so thirsty”. This goes on for thirty minutes or so. Passengers avert their eyes. If you’ve been on a New York subway car, you know what I mean. The man starts crying and screaming, “Oy, I’m so thirsty! I can’t take it anymore, I’m so thirsty!” Finally, a passenger runs to the dining cart, throws money at the attendant, snags a water bottle and shoves it to the lips of the old man. “Drink old man, drink,” he bellows. The old man gulps down the water. Silence ensues.
The old man then starts screaming, “Oy, was I thirsty, I was so thirsty!”
This joke, and the shift to the past tense by the old man, in a nutshell captures the conversation surrounding Chipotle and the broader consumer environment.
October Pressure - Acknowledged by Management
Chipotle, Brinker International, which owns Chili’s, and Wingstop reported results on October 28. All three stocks rose following the release of their earnings.
I published two notes over the past week examining potential consumer weakness. One on restaurants and one on retail. I suggested that we saw an unusually high deterioration of trends across consumer facing companies, as evidenced by consumer panel credit-card spending.
All three management teams acknowledged consumer pressure. Chipotle’s CEO explicitly identified an early-October industry pullback. But he also provided some good news. He said:
We saw some broader industry pullback in the first part of October. I’ll tell you we have since regained positive transactions, and we have high confidence in the balance of the quarter.
Chipotle management said that they anticipate an exit run rate of 3-4% same store sales (SSS) growth by the end of Q4. That represents an acceleration from 2.1% SSS seen in Q3. Driven by the upcoming return of the Smoked Brisket. Other initiatives are underway as well. Chipotle’s CFO anticipates 2% SSS growth in Q4. In explaining that outlook, he described a 3% YoY benefit from pricing, a mix impact of minus 1%, and flat transactions.
That’s a pretty strong endorsement by management that October blues were temporary.
So investors are faced with a dilemma. Should we trust management’s commentary that the weakness has passed? Or risk sounding like the old man on the train, complaining about how bad things used to be in October?
Obviously the third option remains the best. Trust, but verify.
Continue to evaluate the credit card spending data, and see if it confirms the optimism of management. The credit card panel data hasn’t shown a rebound just yet. But the data is not sacrosanct. A negative month-to-date reading can coexist with a recent return to positive transactions.
The CEO of Brinker International, owner of Chili’s, noted the consumer challenges in its call, saying that “we have seen a little bit of mix slippage, which we think is the consumer being under pressure.” The CFO then said, “We did see in October, our mix has gone a little bit negative, but our traffic has more than made up for that.” She then said, “our traffic is accelerating. So we’re seeing those guests maybe do a little check management in alcohol and desserts, but they’re seeing more guests come to Chili’s as that’s where they think the affordable choice is.”
The comments are a reminder that weak consumer trends don’t hit companies uniformly.
Meanwhile, the CEO of Wingstop said, “The macro trends we are seeing among customers have intensified over the last few months.”
Wingstop’s domestic SSS fell 5.4% in Q3. Management reduced its full-year domestic SSS outlook to a decline of 6.5%–7%.
For those of you who are unaware, Wingstop is a fast casual restaurant that sells chicken wings and sandwiches. They’ve been struggling as of late. Their stock is down 43% over the past year. They are heavily concentrated in low to middle income areas.
Cheesecake Factory, which is concentrated in affluent communities, has done rather well over the past year from a stock price performance perspective. Their stock is up 100% over the past year.
Earnings season is ongoing. More companies will report. The key question relates to whether we are seeing an across the board degradation of the consumer. I’d like to hear what more management teams are saying on these earnings calls before putting new money into some of these names.
Is the K-Shaped Economy Changing?
Up until October, we could comfortably articulate the current environment with the term K-Shaped Economy. That’s where different income segments are experiencing a different reality. High income households are thriving, with the stock market hitting record highs. Affluent folks have discretionary spend which they can splurge on luxury items. Meanwhile, middle and lower income households face challenges from persistent inflation which hurts their budget. It makes it difficult to spend on extravagances. On discretionary items.
As you are likely aware, the University of Michigan tracks consumer sentiment. You are likely familiar with the headline number, reported monthly by the media. Currently it sits near record lows, which was achieved back in May. In aggregate, consumers are rather pessimistic.
The headline number is helpful. It’s also helpful to see how households by income level assess their financial situation compared with a year ago. As you can see from the chart below a meaningful gap exists between income groups. Even higher-income households have become less positive than they were a year ago.
We’ve known about weak consumer spending for lower and middle-class households. Not so much on the affluent side. We are starting to see some indications that things are happening across the board.
Mixed Signals Beyond Restaurants
Last week the CEO of Deckers, owner of HOKA and UGG, said something rather remarkable on the company’s earnings call:
We also observed two shifts in consumer behavior: consumers increasingly seeking discounts, concentrating traffic around promotional events, and consumers becoming more purposeful in their spending and prioritizing products with immediate relevance and utility.
Deckers owns premium lifestyle brands. Premium footwear. So the comments suggest that selective spending behaviours now exist, at minimum for purchasers of premium footwear. Possibly it means something for higher income groups.
Does this mean that things are changing though? That’s the question. If things are changing, well, that’s probably not good. It would be even worse if things are changing rapidly, because that means that it’s hard to predict where things are going to end up.
In the earnings call Deckers CEO said, “Consumer behavior is changing rapidly.”
The CEO of Hasbro, when asked about inflationary concerns and consumer sentiment, said rather directly “there is nothing that we see going into the holidays that has us concerned about the consumer.”
Hasbro reported strong growth and raised its outlook.
This is all rather complicated. There’s contradictory information from several companies that reported results.
My understanding is that historically, toy purchases have been more discretionary than footwear. Or restaurants. Footwear is needed. Maybe not in Seattle, but definitely elsewhere. Restaurant purchases are habitual. If I’m wrong, someone in the comments provide me contrary data please.
What the Consumer Panel Shows with Credit Card Spending Trends
The consumer panel data that I rely on continues to provide evidence of a K-Shaped Economy. That being said, October’s restaurant panel weakness wasn’t exactly confined to chains associated with lower-income customers.
Across the 20 chains I examined with Carbon Arc data, 18 saw less YoY spending growth in October than in September. The number showing declining spending increased from four to 14.
Chains associated with middle- and lower-income consumers generally experienced greater deterioration.
I grouped the chains by their customer income profiles and calculated the simple average of their spending growth rates.
Higher-income chains held up better. Middle- and lower-middle-income chains experienced substantially weaker October spending.
CAVA, Starbucks and Chipotle all showed October declines in the panel.
Here are the individual brands:
Each chain serves customers across income levels. So this is inexact. You need to take these groupings with a grain of salt. The panel data I use also provides total spend rather than SSS.
Chili’s accelerating traffic alongside declining panel spending is a reminder of the imperfection with relying on consumer panel data.
Big picture, October spending weakened across most of the brands, with greater resilience among those associated with more affluent customers.
Yesterday the best analyst question award went to David Palmer of Evercore ISI, who asked Brinker (Chili’s) management a question about the K-Shaped Economy. He asked “We’ve heard that perhaps there was a little bit of wobbliness with $100,000 and over consumer and maybe you could speak to what you’ve seen even on a weekly basis and looking into your demographics and any other insights”.
Management didn’t exactly answer the question. They talked about the mix slippage and the consumer being under pressure.
So What Do We Do With the Stocks?
Writing for the sake of writing isn’t particularly constructive. This is all helpful info presumably. But what do we do with it?
The natural bias of folks is to buy and then evaluate the data to confirm trends. By the time the data shows favorable trends, it might be too late.
Chipotle has a great story, with its manifest destiny of opening 7K stores. The consumer value proposition, while weakened with the various price increases since 2019, still exists.
The stock valuation is as low as it’s been for some time. See the chart below.
The problem I see with Chipotle is that management is placed in an uncomfortable spot where they have to thread a needle. Preserve the consumer value proposition while at the same time confronting rising inflation which increases the costs of inputs. How much to pass on to the consumer?
Chipotle saw margin degradation this quarter. Restaurant level operating margin of 23.3% vs. 24.5% in the prior year. Earnings of $0.27 missed consensus expectations of $0.29. EPS declined on a YoY basis.
I like the story. I like the management team. I’m enthused by their comments on the call. I hope that the trends match their forecast.
That being said, I’m still concerned about October. I wish analysts on the call had probed a bit more about what management saw. What did the weakness look like among distinct income groups? When did they see it exactly? When did they see the weakness abate? A couple of days ago? A week ago?
How are things going to trend after the election? Will the consumer chill out a little bit with all the negative ads going away?
Meanwhile restaurant stocks in the chart below have mostly outperformed the S&P 500 since September 30th. Going up even when trends were going down.
I’m still on the sidelines.
As Stephen Stills said sixty years ago when he penned those infamous Buffalo Springfield lyrics,
“There’s something happening here. But what it is ain’t exactly clear.”
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Disclaimer: This is for entertainment purposes only. Do your own research. I have no positions right now in any of the stocks mentioned in this note, but that can change after publication.