The restaurant industry is notoriously competitive and highly fragmented.

However, Chipotle Mexican Grill (CMG -2.57%) has been the exception that proves the rule. The fast-casual burrito chain has returned a phenomenal 3,600% since its 2006 initial public offering (IPO) as the chart below shows, which includes several years when the stock was struggling with fallout from the E. coli crisis.

CMG Chart

CMG data by YCharts

However, after the stock has come so far, it's only logical to ask how much Chipotle can grow from here. This isn't a tech stock that can automatically scale, and there's only so much room in the market for a burrito chain. Chipotle has tried on multiple occasions to expand its concept with different cuisines, including Southeast Asian food, pizza, and burgers, but those fell flat.

The exterior of a Chipotle restaurant.

Image source: Chipotle.

The risk/reward

Chipotle stock has grown multiples since its market debut, but it's still priced as a growth stock. Currently, the stock is expensive at a price-to-earnings (P/E) ratio of 56, but it's still growing quickly.

In its most recent quarter, comparable sales increased 7.6%, driving revenue up 13.7% to $2.2 billion. More importantly, margins continue to ramp up, even in an inflationary environment, as the company gains leverage with higher comparable sales and greater efficiency. It's also added new sales drivers like Chipotlanes and digital/delivery. 

Restaurant-level operating margin increased 180 basis points to 25.3% in the third quarter, and operating margin jumped from 12.3% to 15.1%, driving operating income up 40.3% to $336.2 million. Adjusted earnings per share. meanwhile, increased 35.5% to $9.51.

Chipotle's restaurants now generate average unit volumes (AUV) of around $2.8 billion, putting it among the tops in the quick-service restaurant industry.

The burrito chain hasn't given guidance for 2023 beyond forecasting 255 to 285 new restaurants, but analysts expect strong earnings growth to continue, forecasting adjusted earnings per share of $43.07, up 29% from the expected $33.40 in 2022.  

Based on that forecast, the stock trades at a P/E ratio of just 38. 

The growth opportunity

While the company's current growth rate is strong, it won't be able to open new restaurants forever. Chipotle currently has 3,090 restaurants, and in it's most recent forecast, the company said it believes it can open at least 7,000 locations in North America. 

Doubling its restaurant count isn't going to be enough to justify the current valuation, however. Chipotle's real ability to deliver value for investors comes from ramping up sales at existing locations, which is a more efficient way to grow profits than adding new restaurants. 

In recent years, Chipotle added new levers to grow comparable sales, including adding second make stations to all restaurants to boost capacity, opening Chipotlanes at new and existing locations, and tapping into the digital/delivery channel.

In other words, Chipotle has the ability to grow sales and margins over time, but there is a ceiling on AUV and operating margin. Chipotle will have to improve both AUV and margins to beat the market.

If we make a generous assumption that the company can improve AUV to $4 million and overall operating margin to 20% in five years, and it has 4,500 restaurants by then, it would have $3.6 billion in operating income. If we assume a 20% tax rate and 10% fewer shares outstanding from buybacks, we get an adjusted net income of $3.2 billion, which is 14 times its current market cap. 

Considering Chipotle still plans to open 2,500 restaurants beyond that and should continue to grow AUV at least at the pace of inflation, that gives the stock decent upside potential over the next five years as it's likely to warrant a premium valuation if it continues to execute and outgrow the industry.

If Chipotle can execute and come close to those targets above, the stock could easily double over the next five years, giving it a P/E ratio of 28 then. 

While the stock's hypergrowth is behind it, it's not too late to buy Chipotle stock. This is a top-notch restaurant operator, and it's likely to continue to be a best-in-class stock for the foreseeable future.