Shares of Chipotle Mexican Grill (NYSE: CMG) were down 5.6% at 2:32 p.m. EDT on May 23, following a downgrade by an analyst at BMO Capital Markets in a note to investors.
The analyst, Andrew Strelzik, is concerned that Chipotle's profit margins are set to get squeezed by higher pork prices in coming quarters. For those not aware, African swine fever is devastating pig farms in Asia; some estimates say that as much as 10% of Chinese pork output will be affected this year, and on a global basis, we could see as much as a 4% reduction in pork output.
Higher pork prices could hog some of Chipotle's profits, but that's a short-term problem management can deal with. Image source: Getty Images.
Moreover, it's expected to take multiple years to rebuild global swine populations enough to meet demand, and until then, pork prices are likely to be higher. This has sent lean-hog futures skyrocketing, and Strelzik says that's going to take a bite out of Chipotle's profits.
In the short term, Strelzik is likely to be proved right: Higher food costs have, at times, weighed on Chipotle's profits. What's not so clear is how much, or for how long, Chipotle will struggle under the weight of higher pork prices.
What is clear is that, while the ongoing African swine-fever epidemic is wreaking havoc on pork supply and prices, this isn't a permanent problem. Moreover, Chipotle, like every other restaurant operator, regularly deals with supply-chain challenges and cycles of undersupply with different ingredients. For instance, it seems like we see "Guacamole Armageddon" headlines every few years when global avocado production hits the occasional speed bump.
Bottom line: Managing food supply and cost is a key part of running a business like Chipotle. Initially the company will likely have to absorb some of the higher pork prices. But at some point, management may make the call to raise prices, or even temporarily remove pork items like carnitas from the menu.
But this isn't a permanent problem, and it doesn't alter the long-term thesis for Chipotle as an investment. Chipotle is executing very well right now, and initiatives like delivery and digital ordering are bringing more customers into its restaurants. That should continue even with higher pork prices and supply constraints.
If you liked the company as a long-term investment at yesterday's share price, you should continue to like it after the sell-off today.
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