Is Chipotle Overpriced?

The recent rally of Chipotle Mexican Grill's (NYSE: CMG  ) stock was mostly driven by its better-than-anticipated third quarter financial report and favorable fourth quarter guidance. The high revenue growth was impressive especially in comparison with other big restaurant chains. How was the company able to reach such high sales growth in the past quarter? Let's take a closer look at the company's revenue growth and examine its current valuation in comparison with the restaurant industry and other restaurant chains. 

Chipotle's restaurant growth
Chipotle increased its revenues by 18% in the third quarter. A close examination reveals that most of the growth in revenue was related to the rising number of restaurants, which increased by 14%. Conversely, Chipotle's sales per restaurant rose by only 3.5%. In terms of profit, the company's operating profit grew by 16.6%, while its average restaurant's profit increased by only 2.3% during the third quarter. The table below summarizes this data. 

Source: Chipotle's website

Let's examine how other big restaurant chains have done. To that end, I have considered two companies: The Wendy's Company (NASDAQ: WEN  ) and Jack in the Box (NASDAQ: JACK  ) . I have used Wendy's and Jack in the Box because they, unlike Burger King Worldwide and McDonald's, are mostly located in North America like Chipotle. 

In terms of sales growth, both Wendy's and Jack in the Box have under-performed Chipotle. Furthermore, these companies have reduced their restaurant counts in the past year.

The table below has the data for Jack in the Box: 

Source: Jack in the Box's website

As seen above, Jack in the Box's revenue slipped by 1.1% in the past quarter. Moreover, the company's drop in sales was partly because it had fewer restaurants and lower sales per restaurant. Despite the drop in revenue, the company's operating profit rose sharply by 30% and its profit margin grew to 8.8%. 

Source: Wendy's website

Wendy's didn't do much better in the second quarter : It expanded its revenue mostly due to improved operations per average restaurant. The company closed five restaurants in the past year. Finally, the company currently owns 21% of its restaurants and plans to sell 425 company-owned restaurants to franchisees by mid-year 2014 . This change could suggest that the company is trying to improve its restaurants' profitability and it is less concerned with opening new locations. 

As we have seen above, most of Chipotle's revenue growth was driven by opening more locations. This means that the growth wasn't organic but mostly relied on the company expanding its reach to new locations; this trend could slow down if Chipotle doesn't find ways to finance this growth. So let's examine the company's financial stability and capital expenditure. 

Capital expenditure
Chipotle maintained its capital expenditure in the past year. During the first nine months of 2013, the company's capital expenditure reached $136 million. In comparison , last year the company spent $197 million. Moreover, this expenditure was financed by its own cash from operating activity. Since the company has no debt, more than $300 million in cash-on-hand, and keeps buying back its own stock, it is financially stable. This is another major plus for Chipotle over other big restaurant chains, such as Wendy's and Jack in the Box, that are highly leveraged and have higher financial risk. Let's take these factors into consideration when we examine Chipotle's market valuation. 

Valuation
The high growth in Chipotle's stock price has also reflected into a rise in its market valuation. Based on the company's enterprise value I have calculated the company's EV-to-EBITDA ratio, which will be used to examine its valuation in comparison with other related companies. 

The table below shows summarized data for all three companies along with the restaurant industry average: 

Source of Data: Google Finance, Wikinvest and Damodaran's site

This calculation accounts for the different financial structures these companies have which includes their debt and cash. The yearly EBITDA is based on the past four quarters. As seen, Chipotle's EV-to-EBITDA ratio is the highest at 25.81, which is more than double the industry's average. Wendy's valuation is in the middle of the pack, even though its P/E is the highest; Jack in the Box has the lowest EV-to-EBITDA ratio. 

Even though Chipotle presents higher sales growth and wider profit margins, its high valuation raises the question of whether the company is over-priced in comparison with the market average as well as other companies. Considering that most of the growth in sales is coming from opening new restaurants, I think Chipotle's current stock price is overrated. 

Take away
Chipotle is still an interesting investment: The company has strong financial structure, it continues to expand its reach throughout the U.S, and it presents high profit margins. Nonetheless, the company's current valuation seems high even after considering these positive characteristics and investors may want to stay hold off on buying shares at the moment.

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  • Report this Comment On October 24, 2013, at 1:40 PM, highgrowthcarson wrote:

    Used to be a cmg bear. Now I think I understand. It is all about basic global trends. Healthy, healthy,healthier is an unstoppable trend in rich countries. The wealthier anyone is, the more they want to be thin and eat healthy. Poorer people emulate the wealthy. Chipotle is a great cheap way to emulate the wealthy.

    McDonald's and Jack-in-the-box are unhealthy. No matter what they do they will always be labelled thus and therefore labelled uncool and therefore will see their market share decline over time.

    Note that cmg is super well-run and is the first mover in national casual healthy restaurant chain. I think the price is justified, although barely so.

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