It may sound silly to ask where restaurant company Chipotle Mexican Grill (CMG +1.33%) will be in five years. After all, five years is a long time, and a lot can happen. But making reasonable assumptions about the long term is essential for investors, and five years is a reasonable time frame to consider.
According to a 2006 study from Boston Consulting Group, top-line growth, profit-margin improvement, and higher valuations have historically been the three most significant factors for winning stocks over five-year periods. I believe two of these three will be a challenge for Chipotle, and it's why I think this stock will struggle to outperform the S&P 500.
Top-line growth expectations
Of the things it must do to create shareholder value, growing revenue will be the easiest task for Chipotle over the next five years.
NYSE: CMG
Key Data Points
Chipotle has grown revenue over the years largely by opening new restaurant locations, and it plans to keep doing so for the foreseeable future. The company had nearly 3,500 locations at the end of the first quarter of 2024. But management believes it can double this number over the long term, hitting 7,000 someday.
Over the last three years, Chipotle has opened an average of almost 250 restaurant locations annually. It expects to open up to 315 this year. Given its pace, I believe it's reasonable to think it can open 1,300 to 1,500 locations over the next five years, bringing it to about 5,000 locations in 2028.
Chipotle generated nearly $10 billion in revenue in 2023. Assuming that average sales per location hold steady or increase, the company may generate $15 billion to $16 billion in revenue in 2028. That's a 50% to 60% increase from 2023.
As I said, growing revenue will be relatively simple for Chipotle over the next five years. It has a strong history here, and management believes it has a path forward.
Can there be more profit-margin improvement?
The restaurant industry is notoriously low-margin, but Chipotle is one of the most impressive chains in the world. In Q1, it had a restaurant-level operating margin of almost 28%. In other words, when only looking at sales at restaurants and only accounting for expenses directly related to running those restaurants, Chipotle made about $28 profit for every $100 in sales.
That 28% margin is a really good number for Chipotle. Not only that, it's up big in recent years. In Q1 2019, it only had a restaurant-level operating margin of 21%. When you're a $10 billion business, this improvement from 21% to 28% really has a big effect on the bottom line.
However, there will be a limit to how high Chipotle's margins can go. I'm not positive where that ceiling is, but the company is likely getting close. Chipotle's portion sizes are already getting slammed on social media, a sign that the chain may have pushed its menu prices to the limit of what diners will support.
Looking forward five years, I'd be quite surprised if Chipotle's restaurant-level operating margin was materially higher than it is today. Therefore, I'm not counting on profit-margin improvement to assist with driving shareholder returns.
The valuation is already expensive
Finally, I don't believe the valuation of Chipotle's stock will get more expensive over the next five years. On the contrary, it's already skyrocketed to an all-time high and looks like it needs to come back down to earth.
Trading at over 9 times its trailing sales, Chipotle's valuation is extreme for a restaurant stock and even extreme for Chipotle. The company's five-year average valuation is closer to 6 times sales -- and even that number is high for a restaurant stock.
CMG PS Ratio data by YCharts
If Chipotle stock regressed back to a normal valuation, that would be a headwind against the stock price. In fact, assuming the company generated $16 billion in full-year 2028 revenue and it traded at 6 times sales, then its valuation would be $96 billion. For perspective, its valuation as of this writing is $92 billion.
Put another way, if Chipotle grows revenue by 60% over the next five years but its valuation regresses to normal, then the stock only has 4% upside. In my opinion, that's a real possibility. And if profit margins take any step back during this time, Chipotle's shareholders could see a downside ahead.
Chipotle stock is up close to 50% in 2024 alone as investors excitedly await its upcoming 50-for-1 stock split. But stock splits aren't one of the things that create actual shareholder value over five-year periods. I've laid out the more fundamental drivers to Chipotle's stock price, and looking at these factors leads me to believe that Chipotle stock could fail to outperform the S&P 500 over the next five years.
