3 Reasons Chipotle's Stock Could Drop This Week and Why That Wouldn't Matter

Chipotle reports earnings this Thursday. These 3 results could cause the stock to drop, and make it a "buy."

Jan 29, 2014 at 11:25AM

When it comes to value investors there are two types of people. There's investors who like to buy stocks that are truly beaten-up turn-around plays, such as J.C. Penney or Sears

Then there is a group of investors that I like to call "the relative value crowd." These individuals look to value a stock by comparing the price to relative matters, such as the performance of its business and growth prospects. The relative value crowd follows Warren Buffett's age-old advice to buy a "wonderful company at a fair price," rather than the opposite.

This may surprise you, but I consider Chipotle Mexican Grill (NYSE:CMG) the greatest (relative) value stock of the past two years.

With earnings on tap this Thursday, three key factors could make Chipotle a screaming value this week.

First, here is why Chipotle was the best value stock of the past two years

In my opinion, Chipotle became a terrific value stock over the past two years for two reasons.

1. "Noise."

Billionaire David Einhorn shorted the stock in October of 2012, sending the shares below $300 despite the fact that the business was growing at a healthy clip. Even great investors make errors, and his thesis (that Chipotle customers would gravitate toward value) was clearly flawed. The story (and the name) overshadowed the facts.

2. Once the market realized that Chipotle wasn't dying, it undervalued the power of its growth potential.

In my opinion, this is how truly great value investments are born. Most value investors see opportunity only when a stock drops; however, value occurs more often when the market price can't catch up to (surging) fundamental growth in a quality business. 

It's similar to what happened when Howard Schultz returned to Starbucks (NASDAQ:SBUX). The street undervalued the power of these events. Value investments occur more often when a stock is rising, in my opinion, because investors "anchor" their price targets to the past, neglecting to appreciate an improving business.

I tell you all of this because it's important to realize that Chipotle is not overvalued right now, and any drop could be a bargain.

Traffic in the fast-casual sector has grown 8% over last year, dwarfing fast food growth of just 1%. Typical fast food consumers, are now looking for a healthier option, and Chipotle is leading the way with its commitment to food with integrity.

Further, Chipotle has very few "real" competitors.

Sure, on the surface there are chains like Taco Bell, but no one who "gets" Chipotle's culture (and food) really views them in the same category. It's like comparing the Oasis to The Beatles, or Lebron James to Michael Jordan, the artificial version will have some followers, but the genuine article is always preferred. 

By now you're saying "we get it, Chipotle's a great business." So let's look at some things that could send its stock lower this week, that wouldn't be materially damaging to the business.

Drops for these reasons could signal a buying opportunity.

1. Results that are (slightly) less epic 

As fellow Fool Jason Moser pointed out in this wonderful article, the biggest drop in Chipotle's stock in 2012, came after a quarter that was simply good but not great (not the Einhorn short). Chipotle's most recent quarter was simply ridiculous as same-store sales rose 6.2%, and EPS jumped 17%. Momentum traders had to bid the price up, but it's unlikely to sustain that pace of growth. Slightly less growth (say 5% comps and 14% revenue growth) could create a buying opportunity. 

2. Bad weather, bad results?

In Starbucks recent quarter, North American store traffic slowed down to about 5% growth. The reason, management cited, was the lack-luster holiday quarter for brick-and-mortar retailers. Traffic for traditional retail was down 14.6%, which meant that less people were able to stop into their local Starbucks. 

Could it be that fewer went through Chipotle's doors as well? If so, the stock may sell off.

Some people blame the holiday quarter on bad weather, some say it's a fundamental shift to online shopping. Like Starbucks, I'm not worried about this trend (long-term) when it comes to Chipotle, because their customers are fanatics (I live with one, trust me).

People go to Chipotle and Starbucks because they are seeking out the product--a rarity in the restaurant space, really. So any sell off for this reason, to me, is a buying opportunity.

3. How much room is left?

Finally, there is the question of just how large is Chipotle's addressable market. With 1,500 restaurants, I'm not sure. However, I'm a believer in both the international prospects of this brand, and its successful (albeit slow) ShopHouse roll-out.

If you believe that this management team can pull both off, a pull-back due to a slower "store opening" projection could signal a buying opportunity.

Foolish thought: praying for an entry-point

According to The Nations Restaurant News, the fast-casual sectors currently makes up only 27.25% of total U.S. based food service sales.

When you combine that fact, with the growth of both Chipotle and fast casual, the bullish case for Chipotle becomes clear. With that in mind, I think today's price is not outrageous.

That said, I'd prefer to buy cheaper on a silly, short-term focused, pull-back! Here's hoping we get it. 

Adem Tahiri owns shares of Starbucks. The Motley Fool recommends Chipotle Mexican Grill and Starbucks. The Motley Fool owns shares of Chipotle Mexican Grill and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

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KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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