Chipotle Profits Show Packaged-Goods Companies Can Raise Prices

(Bloomberg View) -- The story for consumers in 2018 appears to be a squeeze on the essentials we buy in our day-to-day lives. Americans haven’t seen that for years.

Despite rising commodity and freight costs, the makers of packaged food and consumer goods companies have been unwilling to raise prices. These titans of industry lose sleep over whether consumers would pay an extra few cents for ketchup or toothpaste, but meanwhile one outlier in the dining industry has taken a risk (out of desperation) and found success.

Chipotles fall from grace began in the summer of 2015 with the first of what turned out to be multiple health scares at its restaurants. Buyer traffic plummeted. Operating costs went up as the chain had to invest more in food safety, and later marketing to win customers back. In the restaurant business, even if your buyer traffic and revenue fall 20 percent, youre still stuck with the same rent and utility bills you had before. Profitability and the stock price tanked.

But a couple things happened over the past year that has Chipotles stock price on the rise again. First, its now been over two years since its 2015 health scares, so anyone still eating at Chipotle is someone willing to look past the negative headlines. And second, the chain raised menu prices by around five percent across the board in three waves — one batch of restaurants last April, another in November, and the last one this January.

Other restaurants with stronger operating trends might have been reluctant to raise prices, preferring to focus on buyer traffic and steady growth. But since Chipotle Mexican Grill Inc. already had so many problems and such volatile traffic, it may have been more willing to take risk and protect profitability by raising prices.

The results speak for themselves, as the first-quarter earnings report showed. Profits rose 29 percent year-over-year. Profit margins are up, even as labor costs continue to be a challenge.

Perhaps most interesting is that Chipotle made a choice that consumer goods companies so far have been unwilling to make: The chain Chipotle was willing to raise prices and sacrifice traffic in the name of profitability. (Prices rose around 5 percent, but comparable restaurant revenue rose only 2.2 percent meaning traffic declined.) And while the stocks of companies like Kraft Heinz Co. and Procter & Gamble Co. that have been reluctant to use pricing to offset cost pressures are some of the year’s biggest losers, Chipotle is one of the year’s biggest winners.

If Chipotle can raise prices, so can packaged goods companies like P&G. They’re called “consumer staples” for a reason. Ultimately, everybody has to buy toothpaste, toilet paper and food. The consumer companies that will suffer least from rising prices will be those packaged goods brands. In all likelihood, raising prices will mean higher profits but marginally lower sales volumes, just as Chipotle has seen. And we should expect those price increases sooner rather than later.

A “Chipotle economy” does have some worrisome possibilities for the economy at large though. “Higher prices and greater profits at lower volumes” sets the U.S. on the path to stagflation, with nominal growth rising because of higher prices but real growth lower as fewer units are sold. Signs of greater inflation are also likely to lead the Federal Reserve to consider increasing interest rates more or faster.

For many months, labor market tightness and cost pressures have threatened to eat into the high profit margins that companies have enjoyed. As that threat becomes real for more and more companies, they would be wise to follow Chipotles lead.

Conor Sen is a Bloomberg View columnist. He is a portfolio manager for New River Investments in Atlanta and has been a contributor to the Atlantic and Business Insider.

To contact the author of this story: Conor Sen at csen9@bloomberg.net.

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