Legendary value fund manager Michael F. Price describes his investing strategy as the "steak and sizzle" approach. He focuses on a healthy balance sheet and steadily increasing cash flow (the "steak") and ignores unproven growth opportunities (the "sizzle"). At Chipotle (NYSE: CMG ) , diners pay for the steak burrito, not the sizzle from the open grill. Can the same be said for Chipotle's shareholders?
Let's grab a fork and knife and take a closer look.
Chipotle's recipe for success focuses on doing just a few things, but doing them very well. The fast-casual restaurant chain serves up burritos, bowls, tacos, and salads efficiently in a sleek restaurant format. The company invests heavily in training employees, which results in a positive customer experience and reduced turnover.
Over the past three years, this strategy has translated into rapid growth in earnings and cash flow. As shown below, earnings per share increased 273% during the same time frame.
Likewise, cash flow has been strong enough to finance future expansion, and the company has minimal debt. Chipotle has been able to fend off competition and even exert pricing power in a highly competitive industry. This consistent operational and financial performance represents the "steak" of a strong, growing business.
The chart above reflects another recent trend for Chipotle: a soaring stock price. Investors are impressed by Chipotle's domestic expansion and are salivating over rising same-store sales. The following table illustrates the trend for this key restaurant metric.
|Same-store sales increase (YOY)||5.8%||2.2%||9.4%||11.2%|
Source: SEC quarterly and annual filings. ^Results reflected through the quarter ended Sept. 30, 2011. All other years as of Dec. 31.
This is savory growth, to be sure, but can it continue? Here are a few challenges Chipotle will face along with an overview of management's past performance.
- Expand through new restaurant openings. Management has shown mastery in this area, opening more than 120 new outlets in each of the past three years, with less than a handful of closures or relocations. The company expects to open 155-165 in 2012.
- Increase same-store sales. In its latest 10-Q filing, management projected same-store sales growth in the low single digits for 2012. This would be a significant departure from the 11.2% year-over-year growth reported for the first three quarters of 2011. However, Chipotle's management has a history of setting a low bar in this category. Management provided "flat" guidance and "low single digit" growth in 2009 and 2010, respectively, and then turned in stellar results. The "lowball" estimate has become a habit for Chipotle, but there will be little room for error going forward.
- Beat analyst earnings estimates. Chipotle topped analysts' estimates by an average of 1% for the last three quarters. Prior to that, the company beat the consensus in three straight quarters by an average of almost 12%. Management may find it harder to top Wall Street's expectations going forward, especially in the face of rising food prices.
While Chipotle has proven it can expand rapidly in the U.S., delivering superior quarterly results could prove difficult in the near future. Currently, the company is exploring international opportunities and experimenting with a new Asian restaurant concept in Washington, D.C. Both represent great opportunities, but management could be overreaching. Investors should be wary of paying a premium for these unproven ventures.
For additional perspective, let's take a look at Chipotle's price-to-free-cash-flow multiple and compare it with the competition. A price-to-free-cash-flow ratio relates a company's market price to its level of annual free cash flow. For Chipotle, free cash flow is the cash left over after paying its bills and financing its restaurant expansion.
|McDonald's (NYSE: MCD )||$94.1||$22.37|
|Starbucks (Nasdaq: SBUX )||$31.0||$24.55|
|Yum! Brands (NYSE: YUM )||$24.6||$21.00|
|Tim Hortons (NYSE: THI )||$7.9||$19.92|
|Panera Bread (Nasdaq: PNRA )||$3.9||$25.10|
|Wendy's (NYSE: WEN )||$2.0||$25.17|
Source: Yahoo! Finance.
Chipotle looks expensive relative to its peers. Its price/FCF multiple is 136% higher than the average of six comparable restaurant chains. Investors are excited about Chipotle's growth prospects relative to the industry and are willing to pay a premium for that growth. But is it justified? Remember that Chipotle's free cash flow number includes the capital expenditures it's using to expand, but its price multiples are elevated even factoring that in.
At the current stock price, shareholders expect a filet mignon from management every quarter. If Chipotle can deliver only a steak burrito, this could result in heartburn for investors.
Do you think there is too much sizzle and not enough steak in Chipotle's share price? Feel free to share your comments below, or keep an eye on this company by adding Chipotle Mexican Grill to My Watchlist.