This Burrito's Undercooked

Don't get me wrong: I think that Chipotle Mexican Grill (NYSE: CMG  ) (NYSE: CMG-B  ) offers yummy food at relatively reasonable prices. But when I'm looking at investment opportunities, as opposed to dinner choices, I have to consider the bottom-line results. In that respect, Chipotle looks a little overstuffed -- er, overpriced -- in this competitive market.

On the surface, Chipotle's third-quarter results aren't so bad. Revenue was up by 18.9%, and same-store sales increased by 3.1%. But what if I told you that the same-store sales increase was primarily driven by price increases from previous quarters? Add that tidbit to Chipotle's plans to increase prices by another 6% this quarter, to counter increasing commodity costs, and you get a not-so-tasty combo meal.

These commodity-cost increases are already hitting profits: Operating margin dropped by 160 basis points to 21.4%. Net income decreased by 5.5%, and EPS dropped by 4.8%, even with the price increases that consumers have already swallowed. Chipotle plans to buy as much as $100 million of Class B shares; while that'll certainly boost future EPS growth, it'll also consume almost 50% of the company's current cash stash.

I love that the company has no debt, and that it will continue to fund its new store openings entirely through operational cash flow. I just question how scared consumers will take a 6% increase in prices that are already hovering at the premium end of the quick-serve restaurant business. Former Chipotle parent McDonald's (NYSE: MCD  ) reported same-store sales growth of 4.7% yesterday, and that comes after increasing its dividend to a 3.6% annual yield, all while keeping menu prices stable, even with commodity cost increases.

McDonald's recent success reflects a trend we've seen across restaurants and retail in general: The Value Menu is trumping premium products. Foodies like Wendy's Arby's Group (NYSE: WEN  ) , Yum! Brands (NYSE: YUM  ) , and Burger King (NYSE: BKC  ) are increasingly competing on price. Will struggling consumers continue to choose Chipotle's premium burrito offerings when they can settle for a Cheesy Double Beef Burrito on Taco Bell's dollar menu?

At a trailing P/E of more than 19, and dwindling same-store sales and earnings growth in today's market, Chipotle just doesn't seem to offer superior long-term investment value, especially when you can buy value-focused and dividend-yielding McDonald's stock at a P/E less than 14.

Further muy caliente Foolishness:

Chipotle is a Motley Fool Hidden Gems and Rule Breakers pick. Looking for more advice in an all-consuming market? Give the Motley Fool's newsletter services a try free for 30 days.

Fool contributor Colleen Paulson does not own positions in any of the stocks mentioned above, but she's always game for a Spicy Chicken Burrito. The Motley Fool has an organic, free-range disclosure policy.


Read/Post Comments (8) | Recommend This Article (11)

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 October 23, 2008, at 1:50 PM, dhd1491 wrote:

    Just a few rebuttals:

    First of all, before the latest price increases, it had been almost two years since Chipotle had increased menu prices...so they were due.

    Second, you can't compare the burrito that Chipotle sells with the crap on the Taco Bell value menu. I doubt that many loyal Chipotle diners are going to make that switch.

    Third, why is it bad to use cash for share buybacks (Chipotle), but good to use it to pay dividends (McDonalds)? One could argue that a buyback is a better way to return shareholder capital as it does not trigger a taxable event.

    Last, and most important for valuation comparisons, does MCD have the potential for doubling or tripling their store count like Chipotle does? Don't you think Chipotle deserves a bit of a growth premium? I know I do.

  • Report this Comment On October 23, 2008, at 2:04 PM, XMFCams wrote:

    dhd has much better points than the columnist.

    Since the question of long-term investment value was raised in the last sentence, I think we should all consider how Chipotles supply chain differs from the competitors mentioned.

  • Report this Comment On October 23, 2008, at 2:15 PM, FoolahMoolah wrote:

    Thanks for your replies. Agreed that the product offerings for Chipotle and Taco Bell, etc are certainly different, but these seem to be a fair comparison in the "fast food space"

    McDonald's actually happened to use cash for both a buyback and dividends last quarter, again positioning it as a strong play.

    My real concern with Chipotle is the lagging same-store sales, especially in this competitive market. Yes, any gain in comps is decent these days, but most of their growth came from price increases, which I don't see as a great sign for long-term growth. They can open more stores, but they need to boost organic growth too, not just increasing their current store sales through price increases.

    Best regards -

    Colleen

  • Report this Comment On October 23, 2008, at 2:46 PM, SteveTheInvestor wrote:

    DHD1491:

    Allow me to rebut your rebuttal....

    I find the idea of dividends much more appealing than share buybacks, thus the reason I own MCD and not CMG. My reasons are fairly well outlined in an article on Dividend.com.

    http://www.dividend.com/blog/?p=1322

    In general, I think CMG will be fighting a lousy economy for some time to come. I realize that CMG has offerings that are superior to Taco Bell, but I don't think that will stop a lot of people from dining at Taco Bell if it will save them a buck.

    CMG's price is up nicely today on their buyback announcement but personally, I'm not going to get excited about it.

  • Report this Comment On October 23, 2008, at 6:11 PM, rogerbowman04 wrote:

    In response to your statement

    “But what if I told you that the same-store sales increase was primarily driven by price increases from previous quarters? Add that tidbit to Chipotle's plans to increase prices by another 6% this quarter, to counter increasing commodity costs, and you get a not-so-tasty combo meal”

    Did you verify this with the company? My burritos have not gone up in years. You must be in one of the few test markets where they raised prices to see the reaction. I don’t think your area will be raised again. I think you are over reacting on how much raising prices in these test areas had on revenue for the whole company.

    I eat at Chipotle almost every day because it is the only place I can find healthy fast food. In Colorado the only comparable stores are Jason’s Deli and Tokyo Joes. Their prices are a little higher than Chipotle.

  • Report this Comment On October 24, 2008, at 5:51 AM, FoolahMoolah wrote:

    The company discussed both the previous and future price increases during their earnings call -

    http://seekingalpha.com/article/101326-chipotle-mexican-gril...

    The previous price increase is discussed on page 3 and the coming increase is on page 4.

    Best regards,

    Colleen

  • Report this Comment On October 26, 2008, at 11:31 AM, srusher wrote:

    I recently bought shares of Chipotle. I tend to stay away from restaurant stocks because consumer tastes change rapidly. But, I love their concept of simple good food and I felt, because of their somewhat premium prices, their comparable store results were more affected by higher gas prices than their lower priced competitors. With gas prices abating, I believe their store comps will improve quicker than might have been expected 30-45 days ago. They seem to have a very loyal following among the college student and recent college grad age groups. I have two children in these age groups and their friends don't view Chipotle as comparable to McDonalds, Burger King or even Taco Bell. While I don't forsee them ever being as large as McDonalds or Burger King in terms of number of outlets, I do see them able to add significantly more stores over the next 3-5 years and therefore being a better growth opportunity than most low end restaurant chains.

  • Report this Comment On November 20, 2008, at 12:36 AM, TMFWillSommers wrote:

    The average burrito price at chipotle is about $6-7. So a 6% price increase is $0.36 to $0.42 per order. From my common-sense perspective, that isn't going to drive people away. Are you going to pack your lunch to save $0.40, will other Americans? No.

    And, to top that off, even with the extra $0.40, Chipotle still represents a great bargain. It is delicious, the ingredients are high quality (largely organic, locally raised, humane meat, etc). It is a HUGE step-up from Taco Bell or McDonald's for just $1-2 per meal.

    When you think about the economy, Chipolte is probably going to benefit, at least to some degree, from trade-down. Instead of going out for a sit-down lunch/dinner for $15-30 per person, people will goto Chipolte for $6-7.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 761377, ~/Articles/ArticleHandler.aspx, 9/22/2014 4:49:22 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement