Is Now the Perfect Time to Buy Chipotle Stock on the Dip?

Chipotle Mexican Grill (NYSE: CMG) reported its second-quarter results late Wednesday afternoon, and in after-hours trading, its stock surged. But on the earnings call, the company warned of near-term margin pressures, and on Thursday, the market erased the stock's initial gains and it kept falling. Chipotle is now down by more than 25% from its recent high, though it's up about 11% on the year.

Has that recent sell-off created a good buying opportunity?

Strong traffic, but near-term margin pressures

In the second quarter, Chipotle's revenue climbed by 18.2% to $2.97 billion, topping analysts' consensus estimate of $2.94 billion. Comparable restaurant sales jumped by 11.1%. Transactions grew by 8.7%, while the average check was up about 2.4%, largely due to increased prices, as mix, which is the difference in menu items sold compared to a year ago, was down about 1%.

Adjusted EPS came in at $0.34, surpassing the analysts' consensus of $0.32.

Cost of sales for the quarter was 29.4%, in line with last year's result. The company said higher menu prices were offset by increased avocado prices and more customers ordering beef menu items.

However, management said that it expected its cost of sales to rise to just below 31% in Q3 due to a combination of its limited-time offering switching from chicken to beef, higher avocado and dairy costs, and making sure some of its "outlier" restaurant locations provide appropriately generous portions.

Labor costs as a percentage of sales were 24.1%, a 20-basis-point decrease versus a year ago, as sales leverage outweighed wage growth. For Q3, that metric is expected to rise to the low 25% level.

Its restaurant-level margin was 28.9%, a 140-basis-point year-over-year increase, and a 140-basis-point sequential increase as well. That's an important metric in the restaurant industry, as it is an indication of how profitable restaurants are at the individual level before adding in corporate costs. Given the above-noted pressures, management said it expects restaurant-level margin to drop to around 25% in the third quarter.

The company opened 52 new locations in the quarter. It also spent $151.4 million on stock buybacks at an average price of $63.52 per share.

For the full year, Chipotle forecast comparable-restaurant sales would grow in the mid- to high-single-digit percentage range. It expects to open between 285 to 315 new locations in 2024.

Image source: Getty Images

Is it time to buy the dip in Chipotle stock?

Chipotle is facing a number of cost pressures going into the third quarter, although those headwinds should largely be temporary. Beef carries lower gross margins than chicken, but the return of brisket as a limited-time offering should help drive overall sales given the popularity of the item. (I for one will be looking to grab a brisket quesadilla when it's on the menu.)

The wide variation in portion sizes, meanwhile, has been well documented, and the company addressing this issue should be good for the overall health of its brand. For its part, Chipotle said that about 10% of its locations were not serving generous portions, and that workers at those restaurants will get additional training. While this will have a negative impact on margins, it should help the company's brand image in the long run.

Meanwhile, the company will look to offset the added costs by gaining efficiencies and making investments to help improve costs and reduce wait times. These will include back-of-house improvements such as adding dual-sided grills at high-volume locations, piloting an automated digital make line, and experimenting with AI and vision technology to help with forecasting and executing orders.

After its pullback, the stock trades at a forward-price-to-earnings (P/E) multiple of under 40 based on 2025 estimates. Typically the company has traded at a trailing P/E of 50 times or more. As the year progresses and future earnings eventually become past earnings, this should naturally help the stock rise if it just maintains its trailing P/E ratio. This is one of the beauties of consistent growth compounding stocks and why they continue to rise over long periods of time. Given its steady expansion, Chipotle has a lot of consistent, compound growth in front it for many years into the future.

CMG PE Ratio (Forward 1y) data by YCharts.

While that doesn't exactly put the stock in the deep discount bin, it is an attractive valuation for a company that has a long runway for growth in front of it. The chain still has plenty of room to expand in the U.S., and has just dipped its toe in the water when it comes to international markets. Combine all of these factors with a concept that continues to draw strong customer traffic and has pricing power, and Chipotle looks like a long-term winner. As such, the recent price dip could make this the perfect time to buy the restaurant stock .

Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chipotle Mexican Grill. The Motley Fool has a disclosure policy .