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Should Investors Buy Chipotle Stock on the Analyst Upgrade?

By Will Healy – Jul 12, 2020 at 10:00AM

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Piper Sandler raised its price target for the restaurant stock to $1,450 per share.

Chipotle (CMG 1.33%) initially moved higher in early Thursday trading before closing lower as a prominent analyst upgraded the consumer discretionary stock. The stock has staged a dramatic turnaround from earlier in the year when shares fell 50%. At that time, investors were fleeing the sector as restaurants closed or scaled back operations.

A few months later, Chipotle stock now trades near all-time highs. However, the contagion remains active, and Chipotle has not yet revealed how the pandemic has affected a full quarter of operations. Amid these conditions, prospective buyers must decide whether to follow the analyst's lead and buy or wait for more information.

The analyst upgrade

Piper Sandler analyst Nicole Miller Regan increased the fast-casual restaurant chain's price target to $1,450 per share. This is up from the previous target of $1,100 per share.

Among the reasons Piper Sandler cited were current checks, survey data, and interviews with people at the company. The analyst added Chipotle's emphasis on digital sales and commitments to development timelines as justifications for the upgrade.

Half a burrito with meat, vegetables, rice, and sour cream.

Image source: Getty Images.

Where does COVID-19 fit into the picture?

Still, some observers might wonder where COVID-19 fits into this? Chipotle did not fall off the cliff during this time, as the company has always maintained a substantial takeout trade. The company also continues to increasingly emphasize its growing digital business, with digital orders rising 81% year over year in the first quarter.

However, with about 80% of orders taking place in the store before the pandemic, Chipotle had to quickly shift to a focus on takeout. At a few of its restaurants, the company added what it calls "Chipotlanes," which involve drive-through or curbside pickup based on digital orders. Also, dining room reopenings also helped to ease the pain. While the percentage of open dining rooms remains fluid, it had risen as high as 40% as of mid-June. And overall, management reported that only 100 or so of its restaurants had to close during the pandemic, primarily a consequence of their location inside shopping malls.

By early June, 70% of all orders took place on digital platforms. For this reason, investors and analysts will be watching the upcoming digital sales numbers closely.

Investors will learn about that and more when second-quarter earnings come out on July 22. This will serve as the first full glimpse into the effects of the pandemic on the company. The contagion only impacted about three weeks of Chipotle's first quarter, though that brief period was still enough to bring about a 9.4% decline in diluted earnings per share, even amid a revenue increase.

A rising valuation

At the worst point of the market sell-off, Chipotle stock fell as low as $415. Since then, it has surged to more than $1,100 per share, breaking through Regan's previous price target.

CMG Chart

Data by YCharts.

However, this has taken the forward price-to-earnings (P/E) ratio to a sky-high 106. That is more than double the five-year average of about 50. That said, depressed near-term earnings related to the pandemic have pushed earnings estimates lower (and the multiple higher). Thus, the valuation should pull back as earnings recover.

For the second quarter, analysts expect an earnings decline of 97% to just $0.12 per share with full-year results down 35%. Looking out a little further, if the forecasts of more than 100% earnings growth for 2021 hold, it would ease many investors' concerns. But nobody knows whether the contagion will have passed by that time, or for that matter, where Chipotle will stand.

Buy on the Piper Sandler upgrade?

You probably only have to drive around your local area to see a landscape littered with restaurant closures. However, Chipotle will likely not become one of those establishments. The company was able to lean on its strong momentum leading into the coronavirus and adapt quickly to the new environment.

However, the company's current valuation dramatically exceeds its historical range and at a time when we do not yet know the full effects of COVID-19 on Chipotle's financials.

Given its growth trajectory, the stock should meet and exceed the $1,450 price target at some point in the future, but with so much uncertainty remaining, this is not the time to pay an ultra-premium valuation.

Will Healy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Chipotle Mexican Grill. The Motley Fool has a disclosure policy.

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