Is Chipotle a Buy After Earnings?

Fast-casual leader Chipotle Mexican Grill (NYSE: CMG  ) reported another quarter of sales and earnings growth earlier this month. However, the company reported a lower operating margin, primarily due to higher food costs, which limited EPS growth to 7.7%. After growing reliably for several years, Chipotle stock has been on a roller-coaster ride for the past year, as investors debate whether the company can continue to grow quickly.

CMG Chart

Chipotle Mexican Grill Two-Year Price Chart, data by YCharts.

While there are legitimate reasons for concern, Chipotle is far from saturating the market, and has very high customer loyalty, which should permit long-term profitable growth. Moreover, its new ShopHouse Asian Kitchen concept will open up additional market opportunities if successful. With the stock trading at a more modest valuation today than a year ago, Chipotle is becoming attractive again for long-term investors.

Is the growth opportunity fading?
In early 2012, it seemed to many investors that Chipotle could do no wrong. The stock ran up from $350 to $440 in the first few months of the year. But investors were particularly disappointed by the company's second-quarter earnings report, because while Chipotle handily beat earnings estimates, it offered weak guidance for the rest of the year.

Subsequently, David Einhorn revealed his short thesis for Chipotle at last year's Value Investing Congress. He argued that Yum! Brands (NYSE: YUM  ) subsidiary Taco Bell would steal customers from Chipotle with its "Cantina Bell" concept. The Cantina Bell menu offers higher-quality food than Taco Bell's traditional offerings, but prices are still significantly lower than at Chipotle. In the current weak economy, some Chipotle customers may opt for the cheaper Cantina Bell alternative.

Chipotle reinforced the perception of lower growth in its earnings report earlier this month. Comparable restaurant sales increased by only 3.8% last quarter, and management predicted "flat to low single digit comparable restaurant sales excluding additional menu price increases" for 2013. On the other hand, the company plans to open 165 to 180 new restaurants this year, which will keep growth rates in the double digits.

No reason to panic
At 36 times trailing earnings, Chipotle is still priced for growth, but not for perfection. While management's 2013 outlook seems weak at first glance, the slower growth is the result of previous menu price increases rolling off. Chipotle's management has made a conscious decision to avoid frequent price increases in order to build customer loyalty. However, with no major price increases in 2012 and food costs continuing to rise, there is a good chance that Chipotle will raise prices this year, which will boost comparable restaurant sales and operating margin.

Chipotle is also beginning to pursue two new growth opportunities. First, Chipotle is entering international markets. At present, there are only 12 Chipotle locations outside of the U.S.: five in Canada, six in London, and one in Paris. Chipotle has been successful in Canada thus far, and will probably expand its Canadian presence rapidly in the next few years. In London and Paris, Chipotle is still working to build brand awareness, but Europe is a big long-term opportunity for Chipotle.

Second, Chipotle is expanding by inventing a new concept: ShopHouse Asian Kitchen. The company opened a test restaurant in Washington, D.C., last year, and is opening two more restaurants in the next few months. ShopHouse provides a Chipotle-like take on Asian cooking, and could generate tremendous growth if successful.

Hungry for more?
Chipotle's stock has been on an absolute tear since the company went public in 2006. Unfortunately, 2012 hasn't been kind to Chipotle's stock, as investors question whether its growth has come to an end. Fool analyst Jason Moser's new premium research report analyzes the burrito maker's situation and answers the question investors are asking: Can Chipotle still grow? If you own or are considering owning shares in Chipotle, you'll want to click here now and get started! 

Read/Post Comments (2) | Recommend This Article (1)

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  • Report this Comment On February 19, 2013, at 6:37 PM, EquityBull wrote:

    I sold most of my CMG position only holding little over 100 shares now. Growth is indeed slowing, quite dramatically now. As store counts have to build on a larger base they either have to open up more stores per year than ever or the increase from store counts will decrease as a percentage.

    I don't think CMG will try to open 15% to 20% more stores on the current base as they feel that is too out of control for them to do well. That leaves them in a position where either more store traffic or menu hikes must provide the growth. At this multiple it is a tougher sell than before which is why I got out.

    I think they also have a same store logistics issue. I wrote to them about slow lines here in some NJ stores. I mean really slow. 25 minutes timed on my iphone slow to get to the register. I watched a few people walk out. I also know I, and others, have gone to alternative restaurants because we simply did not want to wait the almost half an hour to get through the line.

    I don't see how Chipotle can address this issue with their model. Unlike McDonalds they can prepare food ahead of the rush and do it just in time behind the registers. Chipotle relies completely on just in time food to order and there is a maximum throughput so at some point busy stores just won't grow anymore. They may even slip due to disgruntled customers.

  • Report this Comment On February 19, 2013, at 8:38 PM, TMFGemHunter wrote:

    Thanks for the comment. I've definitely experienced the same long line issue, and have walked out of Chipotle once or twice for that reason.

    However, the company has been working on improving throughput, so that stores can handle more customers per hour. I'm not sure how much faster they can go, but the employees can probably speed up a little more with extra training. Also, the existence of long lines shows that Chipotle has not saturated its core markets. It could add restaurants even in cities where there are already a lot of locations, and draw customers who would have walked out from the other locations because the lines are too long.

    CMG is planning to grow locations by 12%-13% this year, and that's probably a realistic rate for the next few years. All of the evidence I've seen points to the company's pricing power, so it can further boost sales/margins by raising prices (perhaps this spring or summer). I think those parameters can justify the current stock price.


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