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This week's earnings report for Chipotle held a lot of water for the company. Since the company's giant mid-July sell-off, investors have been waiting to see if improvements are on the horizon for what once was a true Wall Street darling. Unfortunately for the company and its investors, it was a lousy report. The company missed on both top and bottom lines, sending the stock down more than 10% in after-hours trading on Thursday. Was David Einhorn right about the burrito fabricator? Is it time to move on, or even short the company?
Only a few months ago, around April, Chipotle Mexican Grill (NYSE: CMG ) was trading well over $400 per share, and drastically overvalued. It was an enticing short for many, but the company has had a history of trading at lofty valuations. To me, though, the story brings to mind a classic Keynes quote: "The market can stay irrational longer than you can stay solvent."
Well, the shorts won this time. Since that July sell-off, it's been a downhill ride for the company. At the recent Value Investing Congress, David Einhorn presented his case for shorting Chipotle, and why Yum Brands (NYSE: YUM ) would steal away market share with its revitalized Taco Bell menu.
Most of the value guys I spoke to were in line with Einhorn's call, but other investors were holding out for this earnings report to see some sign of change in the company's direction. Sorry, optimists, not this time.
If one were to read the company's press release, the earnings didn't look all that bad:
- Revenues up 18.4% yoy
- Comps up 4.8%
- 36 new restaurants
- 7% increase in restaurant level operating margins
- Net income up 19.5%
Sure, those numbers look fine in isolation, but the Street was looking for more. The slowdown in Chipotle's growth does not signal that the company is headed for the dumpster, but it does tell the market that the era of extreme valuations for the company may be coming to an end.
Even more discouraging is the company's guidance for flat to low single-digit comparable sales growth in 2013. That information, coupled with a 26 times forward earnings premium, makes for a bad stock forecast.
So what are the factors affecting Chipotle's growth?
It's not that Chipotle's quality is suffering, or that its management is doing the wrong thing -- it's still a well-run company with a great product. It's a variety of external factors that seem to be keeping the company from achieving what Wall Street wanted.
For one, commodities prices are rising, and negatively impacting the business. The Chipotle CFO told Fox Business back in August that all ingredients would be more expensive going forward -- and it looks like we're seeing those effects now.
Another thing going against the company is the Einhorn affect. Whether you like the hedge fund manager or not, David Einhorn has become a real market mover. When he presented his case against Chipotle, it was a well-organized and easy-to-follow thesis as to why the company is sailing into strong headwinds. And it's not just Einhorn saying the company is overvalued, it's him putting his money where his mouth is. His firm's short in the company shows investors that one of the top hedge fund managers in the world is deeply convinced that this story is a declining one.
Yum Brands' Taco Bell has had a very successful remodel, thus far. The company has introduced new burritos and burrito bowls that compete directly with Chipotle's offerings. While it will take some time for people to consider Taco Bell on par with Chipotle in terms of quality and sustainability, it looks to be an idea gaining traction fast, especially with Yum Brands posting impressive same-store sales gains for its Taco Bell stores.
Chipotle has always attracted investors who strongly believe in its business model and what it has to offer society -- healthier fast food. In that light, those who originally believed in the story will likely remain there. Value investors haven't been too interested in the stock due to its high valuations, which, despite its major sell-offs, is still well above its competitors.
In my opinion, Chipotle remains overvalued and has a decaying environment for at least the next year. If you trust wholly in the concept, and are in it for the long run, now is certainly not the time to sell. But for those attracted to the recent shares on sale, stay away -- this is quickly becoming a stock you don't want to become involved in any time soon.
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