At $550, Could Chipotle Mexican Grill Look Cheap?

Chipotle Mexican Grill (NYSE: CMG  ) cooked up an outstanding quarter to end 2013, by nearly every measure. Words like "blowout" and "soaring" were used to describe the burrito maker's results and subsequent 12% stock increase.

But as some of my colleagues and several Wall Street analysts have pointed out, this is no time for investors to buy into the original gangster of fast-casual food. Or is it?

As my experience with the stock proves, there's more than one reason to believe Chipotle's shares are attractive even at an all-time high.

Chipotle in Manhattan. Source: Chipotle Mexican Grill.

Backtracking on the burrito maker
In late 2011, I dissected Chipotle's business model and stock price with a paring knife in an attempt to understand the restaurant chain's tremendous growth story. At the time, shares of Chipotle were up 700 percent in three years, commanding a price greater than 50 times trailing earnings and cash flow. Both metrics seemed beyond belief for a brick-and-mortar business, especially according to pundits.

The emerging opinion was that this restaurant had little room to run. In the financial media, we heard stories about similarly lofty valuations reached by restaurants like McDonald's in the late 1990s or even the earlier, much-hyped Boston Chicken, which flew quite high before crashing back to earth. Surely, Chipotle's growth, especially without the leverage of a franchising model, would subside.

After conducting substantial research on this founder-led restaurant chain, I became enamored with the management team, the restaurant economics, and the growth potential in the fast-casual market. Nevertheless, I ultimately agreed with the naysayers in my article titled, "Chipotle: Buy the Steak, Not the Sizzle."

I homed in on one key metric: price-to-cash flow. As any analyst worth his salsa will say, this is a true gauge of what an investor pays for in a business. Chipotle's, at the time, towered over six of its peers, clocking in at 54.4 versus an average of 23.2, a premium of 136%. The value investor in me (whose voice is fading over time) just couldn't swallow such a pricey burrito. From my perspective, any less-than-perfect quarter from Chipotle would "result in heartburn for investors" down the road.

How Chipotle fared 
Sure enough, Chipotle did falter in 2012, temporarily, and the stock dipped in large part due to a short call and presentation by value investor David Einhorn. As a result, several buying opportunities presented themselves along the way. Those who bought on the "Einhorn dip" have witnessed returns of 120 percent, yet Einhorn's short position remains intact as of last November.

Needless to say, how did my thesis fare? Despite the fact that Chipotle seemed "priced to perfection" by all accounts, the company's stock has risen by 74% since I published my take in November 2011. Had I bought shares and held, I would have beaten the S&P 500 by 29% and the Dow Jones Industrial Average by a whopping 43%.

What's more, I might have been more inclined to pick up shares on the dips if I still believed in the long-term prospects of the company. All of these actions could have added up to a nice market-beating annual return from a tremendously well-run company.

Alas, the shares were just too expensive, like Chipotle looks just too expensive today.

But let's delve into the numbers for a moment. Back then, Chipotle's average same-store sales growth for the prior three years was 7.6%. After the recent year-end results, Chipotle's updated three-year average is higher, at 8.1%.

Restaurant growth, meanwhile, clocked in at 14% from 2009 through 2011. In the last three years, that number's stayed right on par, at 14%.

Key Metric

2008

2009

2010

2011

2012

2013

Same-store sales increase (YOY)

5.8%

2.2%

9.4%

11.2%

3.8%

9.3%

Restaurant growth (YOY)

19%

14%

13%

13%

15%

13%

Restaurants opened

133

121

129

150

183

185

Source: Chipotle investor relations and SEC quarterly and annual filings. 

By these measures, Chipotle's momentum has yet to slow, even though some analysts believe there's a ceiling limiting the chain's growth. On the contrary, I would argue that the future looks even more promising today than it did a few years ago.

Why Chipotle's future looks spicy
In 2011, Chipotle was a one-trick pony, almost entirely focused on serving Mexican fare to the American market. Today, Chipotle's well on its way to becoming a fast-casual restaurant empire, with 16 international locations and budding concepts in Asian cuisine and Neapolitan pizza through ShopHouse and Pizzeria Locale. Yes, the store counts for the latter two are small, but the rate of restaurant openings should exceed that of Chipotle's in the early days. As co-CEO Steve Ells pointed out on the conference call:

When we are ready to expand at a faster rate, we certainly have the infrastructure in place ... [W]e have so much information on 1,600 specific sites now in the U.S. with Chipotles, and so we know exactly what regions, what markets, what intersections we would want to go to with these new concepts.

The runway for each concept could be just as long as Chipotle's, but the company can accelerate along it at a faster pace.

And meanwhile, Chipotle's not finished capitalizing on its existing set of restaurants. The new catering business is driving additional foot traffic and there's reason to believe that the company has a breakfast menu in the works. Both opportunities require less up-front investment than new restaurants and could thereby translate to even faster earnings growth.

At first blush, Chipotle's shares look pricey today, similar to 2011. Still, the following chart shows that the stock is trading slightly cheaper in terms of price-to-cash flow than it was when I penned my first article.

A closer look at Chipotle's recent results provides perspective for those who simply write off the stock as "overvalued." Personally, I think the company will continue to outperform the market -- our ultimate goal as investors -- in the years to come.

Does it look cheap? Perhaps not by traditional measures, but winning companies tend to keep on winning. Plus, there's plenty of "optionality" for the company to grow the top line through a variety of new concepts. At this point, who am I to doubt a company that's grown revenue at an average rate of 30% over the past decade?

Instead of waiting for the line to die down or Chipotle's price to decline, perhaps investors should step up and take a bite of the burrito.

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Read/Post Comments (9) | Recommend This Article (32)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 06, 2014, at 5:24 PM, EquityBull wrote:

    CMG is a great company but ultimately it will come down to valuation, in particular the multiple. CMG traded at just 23 times earnings just a few years ago. Now it trades for 42 times this years projected earnings of 13/share.

    If market sentiment or growth declines this stock gets whacked hard on multiple compression. A simple PE drop closer in line to its 30% EPS growth would be a 30 PE on that 13/share in EPS. That gets you to 390. Worse yet if growth really slows for a quarter or two now you might see PE of 20 to 25. At 20 the stock is still more expensive than most restaurant stocks and would drop to 260/share. That is quite a drop from 550 today.

    All the risk is in the multiple right now which is rich. The gamble is whether it will always stay risk or at what point does growth slow and the high multiple shrink to just being "inline". At that point some pain is coming as the stock resets.

    I sold most of my CMG during the einhorn scare on valuation. I still believe CMG is priced for perfection and has an unwarranted premium of at least 150/share. It would not surprise me if any day this premium came off. This is not a margin of safety stock that Buffett would buy.

    I've held a chunk of the stock simply because my tax bracket maxed out and I had a big gain on that block so figured I would just let it ride for the long haul. At the moment I'm thankful I did but time will tell. It wasn't long ago CMG went from 440 to 285 in a heartbeat. Investor sentiment can change just like that....when it does I'll be adding to my remaining shares!

  • Report this Comment On February 06, 2014, at 7:31 PM, TMFBoomer wrote:

    @EquityBull

    Thanks for the comment. I hear your concerns, and I agree that Chipotle's price-to-earnings multiple is in another stratosphere compared to most restaurant chains. The market's really optimistic about what Chipotle can accomplish, but this is still - as I pointed out - charted territory for Chipotle's stock. Investors who bought when the stock was trading at a 50 P/E in 2011 have seen a handsome increase in the value of their shares and outperformed the market (if they held on).

    Can Chipotle's momentum continue? Well, earnings growth over the past 5 years averaged 33% whereas the total stock return averaged 62%. That's a fast-growing multiple. Investors, like myself, look increasingly convinced that Chipotle's in the early innings here with only 1,600 restaurants. Compared to McDonald's, for example, Chipotle's 1/20th of the size in restaurants and 1/9th in revenue. Chipotle's different in terms of operations when compared to McDonald's and might not resonate the same overseas. However, there's a huge market for pizza, so who knows where this Pizzeria Locale concept could go from here. We'll see whether Chipotle ups its equity interest in PL in the future.

    Personally, I think Chipotle can build on both ShopHouse and Pizzeria Locale and the total store count could reach 1/5 of McDonald's at over 6,000. I'd have to run all the numbers and estimate how long that might take, but I think investors today would make money should that happen.

    With this stock my time horizon is 5 to 10 years, though, so we're talking about the long haul.

    Isaac

    @TMFBoomer

  • Report this Comment On February 08, 2014, at 12:08 PM, Stockgamblr wrote:

    Great stock! I've had it for 4 years and it's gone up 1,023%. Friends ask me why I don't sell it, but it's ethically sound, and still going up!

  • Report this Comment On February 08, 2014, at 4:43 PM, lowmaple wrote:

    There is a huge disparity between the multiple now and 23 but was that after Einhorn shorted it? If someone else tried to push the price down would the market react as strongly? Wonder how long he'll hold that position.

  • Report this Comment On February 08, 2014, at 5:43 PM, JimNewman75 wrote:

    Using a blend of DCF models (perpetuity and exit multiple) with relative valuation analysis, the calculated fair value for CMG is $475/share. Therefore, the current price ($549.28) is nearly 30% overvalued. Coupled with a 30% margin of safety, this is right at the recommended sell point.

    I would expect to see this lofty price from a high-flyer technology stock, but CMG is a brick & mortar fast food restaurant. Yes, there are strategic options that can be factored in, but at this price point CMG is a bit rich for my taste.

    I would wait for a better entry price.

  • Report this Comment On February 10, 2014, at 1:24 PM, dsciola wrote:

    Good article Isaac. In my opinion, you get what you pay for more often than not in today's markets...mainly due to market's being more and more efficient.

    Would you consider P/FCF as good, if not better, a metric than P/CF for CMG? My guess is CapEx, and maybe cash for M&A, may be high for CMG, but nonetheless a quality metric as both of em, CapEx and M&A, are key value drivers for CMG.

    Dom

  • Report this Comment On February 13, 2014, at 9:50 AM, TMFNewCow wrote:

    Great article, man.

    -- Evan

  • Report this Comment On February 13, 2014, at 3:09 PM, TeenStockPicker wrote:

    Nice article!

  • Report this Comment On February 13, 2014, at 5:47 PM, Raphael1990 wrote:

    You shouldn't assume that it is worth paying a cashflow multiple of more than 50 for a company that grew revenues at 20% in 2012 and 17% in 2013 (notice the trend) just because the stock managed to maintain its valuation over a couple of years.

    George Soros says: The market is almost always wrong, but it validates itself most of the time.

    CMG keeps validating its valuation which is not that surprising considering we are in one of the greatest bull markets of all time. You are prooving with your own behavior that there are people in the market who buy stocks regardless of valuation. The process is selfvalidating and selfreinforcing. It happened in the "GoGo years", it happened in the 90s, it happens all the time with individual stocks.

    Why would people pay such high prices for example in the GoGo years? Because people are affected by recency bias. Stocks of great companies rise skyhigh over several years and people actually start believing what the market is trying to tell them: That great businesses are worth paying anything for. Until it ceases to work.

    Even if CMG manages to accelerate their growth again, it's not going to be enough. It might take another two years, but eventually Cashflow will matter again. And the painful thing is, the stock is not even going to crash fast so you can buy more at cheap prices. It's going to make the Coca Cola move.

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