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The Motley Fool has been making successful stock picks for many years, but we don't always agree on what a great stock looks like. That's what makes us "motley," and it's one of our core values. We can disagree respectfully, as we often do. Investors do better when they share their knowledge.
In that spirit, we three Fools have banded together to find the market's best and worst stocks, which we'll rate on The Motley Fool's CAPS system as outperformers or underperformers. We'll be accountable for every pick based on the sum of our knowledge and the balance of our decisions. Today, we'll be discussing Chipotle Mexican Grill (NYSE: CMG ) , an operator of fast-casual Mexican food restaurants in the United States, Canada, and England.
Chipotle Mexican Grill by the numbers
Here's a quick snapshot of Chipotle's most important metrics to better acquaint you with the company:
Result (TTM or Most Recent Available)
|Cash/Debt||$464.7 million / $3.6 million|
|5-Year Revenue CAGR||22.5%|
|Key Competitors||Panera Bread (Nasdaq: PNRA )
McDonald's (NYSE: MCD )
Starbucks (Nasdaq: SBUX )
Sources: Morningstar, Yahoo! Finance, Chipotle 10-Q, and author's calculations. CAGR = compound annual growth rate. TTM = trailing 12 months.
Chipotle Mexican Grill has arguably been one of the best growth stories in existence since the recession. Chipotle's share price has rocketed higher by nearly 1,000% since closing below $39 in November 2008 and has done so on the back of double-digit same-store sales growth, impressive pricing power, resistance to commodity prices increases and rapid store expansion.
At the heart of the Chipotle movement is a push toward organic, fresh products. Chipotle's emphasis on producing "food with integrity" means it's focused on the use of meats whose suppliers have, within reason, avoided the use of antibiotics and chemicals. With more than a third of America currently obese, a healthier eating movement is under way and Chipotle is seizing the reins. This is exactly why revenue jumped by 26% in the first quarter and comparable-store sales were up almost 13%.
But just as there are reasons to be excited about Chipotle's growth, there are reasons to be very concerned about its current valuation.
In terms of commodity costs, Chipotle has cautioned that costs are expected to rise by the low-to-mid single digits. While it does have pricing power, it will not budge on prices this year as consumer discretionary spending is still skittish at best.
Perhaps the biggest red flag in Chipotle's valuation becomes apparent when you break down its relative market value per restaurant versus that of some of its closest casual-dining peers.
Source: Yahoo! Finance, author's calculations. Calculation takes into account owned, franchised, and licensed locations, and utilize market caps as of market close July 20, 2012.
The calculation becomes even more skewed when we add in trailing-12-month operating margins:
Source: Yahoo! Finance.
I consider this a pretty fair comparison as these restaurants are often very similar in square footage and all four have been expanding rapidly despite a weak economy. As you can see, investors have assigned Chipotle a market value per restaurant that's more than triple that of its closest competitor, McDonald's, despite the fact that McDonald's is significantly more effective at getting the most out of each dollar. Starbucks' restaurants only sport 23.7% of the market value per restaurant that Chipotle's restaurants command despite having only a marginally lower operating margin. Starbucks does, however, have an inside path to faster growth in China, something that Chipotle currently lacks. Even Panera Bread, which I condemned earlier in this weekly roundtable, presents a more attractive value despite having the lowest operating margins of the four.
Taking all of this into account, I'm a seller of Chipotle's stock here given what I feel is a rampant overvaluation.
I am a big fan of Chipotle's food, and I'm not the only one. It is one of very few quick-serve restaurants I've ever been to that tends to be packed regardless of location and time. I've been to locations that were packed at 3 p.m. on a Thursday, and others that had lines out the door at 6 p.m. on a Saturday. The company has intense brand loyalty, the likes of which few restaurants -- let alone chain establishments -- can muster. But brand loyalty on its own isn't enough. We also need to look at the cost of ownership, and in this instance, Chipotle may fall short.
The obvious takeaway from this is that Chipotle's valued more highly than its restaurant peers, and even beats Whole Foods Market (NYSE: WFM ) , with which it shares a sort of kindred mission to bring more natural foods to the masses. But the total five-year change is a little different. Panera Bread's P/E has grown more than Chipotle's, which is only 12% higher than it was in 2007. Whole Foods turns out to be the stock undergoing the most P/E growth, and yet that company's 50% increase doesn't bring it past Chipotle's present 57 P/E.
Chipotle stockholders probably don't need to worry about its fans turning against it. A more pressing concern is that valuation, especially when you consider the risk of another downturn sparking a sell-off. Chipotle's current P/E is 36% above its five-year historical average, and is approaching its 2007 levels. Ominous! That's despite annualized after-tax income growth of 39% per year for the five-year period.
Chipotle's done a great job handling its costs as it expands, since net income's grown almost as briskly as its total stock gain over the last five years, thanks to expanding profit margins. But its peers have done even better:
Panera and Starbucks have both smoked Chipotle on a relative basis when it comes to squeezing more profit out of their operations post-recession. Whole Foods has smoked everybody. The only company that hasn't beaten Chipotle is the one not popularly known as a purveyor of quality products.
Still, despite the potential for further gains, I have to temper my enthusiasm. Chipotle is still one of the most expensive restaurant stocks around, and no stock can keep growing faster than its underlying earnings forever. I'd love to get into Chipotle at a lower price, but not now. I'm staying away from the stock for the short term -- but I'll keep enjoying those burrito bowls.
I understand and agree with what Sean and Alex have said so far, but I'd like to take a step back and see how large Chipotle could grow. Yes, Chipotle's stock is expensive right now; it has been ever since it hit the market, but what we're paying for is what Chipotle will be in the future.
We know by the market value per restaurant Sean provided above that Chipotle manages to squeeze more out of a location than any of the competitors mentioned, but it also has far fewer restaurants than those competitors. This provides tremendous upside in the future.
At the end of the first quarter, Chipotle had 1,262 stores and grew restaurant count by 2.6% in the quarter, much faster than competitors. For the full year, restaurant count is expected to grow by 155-165, or 12.6%-13.4%. That's solid growth even before you consider the fact that comparable restaurant sales grew 12.7% in the first quarter.
|Stores Open Q1 2012||1,262||1,562||33,517||17,420|
|Net Stores Opened During Q1||32||21||7||176|
Source: Company earnings releases.
Chipotle doesn't have the kind of business or price structure to ever reach the size of McDonald's, but the company still has a long way to go just in tapping the U.S. market. I can count on one hand the number of Chipotle restaurants from Minneapolis to Seattle, and I don't know of a single metropolitan area that is saturated yet. Add in international growth and I could see there being 10,000 Chipotle restaurants in the future and Chipotle could easily have 10 times the revenue it has now. I don't know what the time frame on that would be, but a restaurant growing comparable-store sales by double digits and store count by double digits is seeing some pretty explosive growth.
What does all of this mean? It means that a 37 forward P/E ratio may not be as crazy as it looks on the surface. Don't get me wrong, I'm not rushing out to buy Chipotle shares at that price, but I'm certainly not excited about an underperform call. I'll sit out for now and revisit Chipotle when its P/E falls below 30.
Despite valid concerns regarding Chipotle's valuation (expressed by Sean and Alex), all three of us recognize that Chipotle has amazingly loyal customers and a phenomenal growth rate over the past few years. Although we have suspicions about whether it can maintain that growth or its premium valuation relative to its peers, the majority opinion appears to be that we'd rather wait on the sidelines for Chipotle to get cheaper than bet against what has been a runaway train that's shown few signs of slowing.
Although we've chosen not to enter a CAPScall today on Chipotle, you can reference our previous selections at the TMFYoungGuns CAPS portfolio.
Even if Chipotle isn't the right stock for you, perhaps the three stocks our analysts at Motley Fool Stock Advisor have chosen as companies ready to dominate the emerging markets might be. McDonald's is one; find out the other two by clicking here to get your free copy of this latest report.