What: Shares of fast-casual Mexican food restaurant chain Chipotle Mexican Grill (NYSE:CMG) fell nearly $11 in Friday's trading session to close at $659.92 despite receiving a price target increase from research firm Argus.
So what: According to Argus covering analyst John Staszak, in spite of what's being perceived as a weak fourth-quarter earnings report from Chipotle last Tuesday, the company's long-term prospects are inadequately reflected in its current share price.
Staszak specifically mentions that Chipotle's operating margin is around double the industry average, and that its focus on local and organic foods should be a boon to its sales. Staszak also focuses on Chipotle's aggressive expansion plans, especially in underdeveloped markets where costs are low, as a reason to be bullish about its prospects.
When all was said and done Staszak and Argus maintained a "buy" rating on Chipotle, but boosted its price target, or what they believe the fair valuation of Chipotle to be, from $750 to $780. At this level the company is implied to have 18% upside from Friday's closing price. The company's 52-week high is $727.97, according to S&P Capital IQ data.
Now what: The question investors have to ask themselves is whether Argus' price hike has merit. In other words, are shareholders ignoring some obvious strengths in Chipotle's business model?
On one hand it's very difficult to dismiss Chipotle's superior results quarter after quarter. In its recently reported fourth quarter it delivered 16.1% comparable-store sales growth, restaurant-level operating margins of 26.6%, a 26.7% increase in revenue to $1.07 billion, and a 52.3% jump in net income to $121.2 million. These results essentially prove that consumers' habits are continuing to shift toward more nutritious and locally grown foods. It also shows that timeliness is still a key component to running a successful restaurant chain.
Additionally, after holding off for quite some time on boosting its prices, Chipotle hasn't had any difficulty in passing along price increases. Consumers understand there's a premium to be paid for more nutritious food, and Chipotle's had little to no pushback from consumers based on its last price hike. This is particularly good news since Chipotle announced this past week that it's considering another round of price hikes in response to rising beef prices.
On the flip side, Chipotle stock isn't cheap by any measure of the imagination. Even after its post-earnings tumble, Chipotle finds itself valued at 32 times forward earnings, 10 times its book value, and nearly 24 times enterprise value to EBITDA. But these figures don't give an accurate representation either to Chipotle's outperformance of its peers or the loyalty of its customers.
Ultimately, I do believe there's some merit to Argus' upgrade, but I'd probably cap my enthusiasm for Chipotle around a PEG ratio of two. Currently Chipotle's PEG ratio is 1.8, implying modest upside from here, in my opinion.