Chipotle Mexican Grill's Long-Term Prospects Remain Strong

Last Thursday, Chipotle Mexican Grill (NYSE: CMG  ) reported results for the first quarter of 2014. The market ended up pushing shares down 5.94% to $519.61, possibly due to fears that the company's planned price increases may deter customers. For long-term investors, however, the company's prospects are as bright as ever. 

Chipotle can handle price increases
Chipotle saw sales increase 24.4% year over year to $904.2 million in the first quarter, but net income only increased 8.5% to $83.07. Margins were pressured by rising commodity prices -- particularly with beef, avocados, and cheese -- and pushed management to announce Chipotle's first system-wide price increase across the U.S. since 2011. Management anticipates these price increases to be rolled out by the third quarter of this year. 

While investors should keep a close watch on how these price increases impact customer visits and overall sales, I think it is unlikely that low single-to-mid digit percentage increase in prices will significantly impact customers. As a conscious capitalism business focused on its Food With Integrity mission, Chipotle has built a loyal (and growing) customer base. 

This quarter, for instance, comparable restaurant sales increased an astounding 13.4%, and average restaurant sales hit a record of $2.23 million per restaurant. Chipotle offers an experience that few (if any) national restaurant chains have been able to match, and the numbers prove it.

"Ultimately," as founder and co-CEO Steve Ells explains, "it's our belief that the more people know about their food and how it was raised and where it comes from, the more likely they will be to eat at Chipotle." Given Chipotle's financial performance, it is hard to argue with that statement. 

Focus on the cash flow 
Shortsighted investors are focusing on the short-term impact that rising commodity prices are having on Chipotle's bottom line. Many investors, however, are missing a key statistic that demonstrates just how impressive Chipotle's business is: free cash flow

In the first quarter, Chipotle's free cash flow production increased 49.34% to $132.55 million. This cash flow performance allows Chipotle to open more than 40 new restaurants each quarter without adding any debt to the balance sheet. In fact, Chipotle now carries $411.59 million of cash with no debt. 

Long-term investors should focus on Chipotle's free cash flow performance going forward. Few restaurants, let alone businesses, come close to achieving the continued excellence of cash flow production demonstrated by Chipotle. In terms of cash flow production, Chipotle is as strong as it's ever been, and patient long-term investors should take notice. 

ShopHouse and Pizzeria Locale concepts off to a good start
We didn't learn much more about Pizzeria Locale or ShopHouse in this quarter's press release or conference call. However, Steve Ells did disclose that the volumes of Pizzeria Locale and ShopHouse are "behaving similarly in general to how we saw Chipotle going into early markets back when Chipotle was kind of unknown".

When it comes to Pizzeria Locale and ShopHouse, Ells explains they are "seeing patterns that are very similar to what we saw with Chipotle in the early days, and we find that to be very encouraging." Considering that Pizzeria Locale and ShopHouse are already opening new locations at a faster pace than Chipotle in its early days, long-term investors have reason to be optimistic that these new concepts can complement Chipotle's growth in the coming years and decades.

Foolish final thoughts
The market presently values Chipotle at $16.15 billion with a P/E ratio of 48.74. While this doesn't appear to be a bargain, I think this is a valuation that Chipotle can justify and grow into. Within the past several years, I made the foolish (small f) decision to sell shares of Chipotle based solely on price movements. Big mistake. Chipotle's long-term prospects are as bright as ever and will likely command a premium valuation for quite some time. 

With Chipotle we have a proven values-driven management team with an unprecedented ability to generate cash flow. Should the market continue to discount the strength of Chipotle's business and push shares downward, I will strongly consider adding to my existing position. Patient long-term investors shouldn't go anywhere, because Chipotle's growth is far from over. 

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  • Report this Comment On April 23, 2014, at 9:20 AM, EquityBull wrote:

    You were prudent to sell CMG on price movements. It's a great company. The future is bright. However the stock returns are not going to be over the next few years unless it manages to levitate and trade many years ahead of fair value. At today's premium great numbers are priced in for the next 5 plus years and any slip by Chipotle can bring the valuation to just "in line" (i.e. PEG to equal growth).

    Even with current EPS at anemic 8.5% growth levels and the PE at about 700% higher the stock remains wildly overvalued. A simple correction to a PEG of 1.0 (PE to match growth rate) would bring Chipotle down to a PE of 25-30. That means a valuation in the 300 to 350 range. 400 would be generous. At some point it would be easy for the market to not apply an above market multiple for Chipotle. With just 24% top line and 8.5% bottom line does Chipotle deserve this high PE TODAY? I don't think it does. That is a huge amount of risk that they will keep growing EPS at 30% in an environment which has factors they either can't control or improve upon (i.e. inflation and throughput respectively)

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