Wednesday, June 23, 2010

Chipotle Mexican Grill: 1000 and Counting

Yesterday morning, Tuesday the 23rd, a friend asked me how I felt about Chipotle Mexican Grill (CMG), since I had advised him to get McDonald’s (MCD) at under $67 a few weeks ago as a defensive investment and he wanted something a bit riskier. I responded by saying I didn’t know too much about Chipotle, I’ve never even eaten at one, but that there would be a follow up email shortly. So I decided to do a little research. I had known that Cramer has been extremely bullish on it as a member of his CANDIES list of stocks that he thinks will continue to grow even if the market drops again. A few clicks into the Bloomberg later I saw just how much Chipotle has been thriving, up from $50 to $150 since its bottom in 2009. My follow up was that it currently looks a little inflated based on the dramatic rise in price and looking at their P/E of 33 as compared to McDonald’s (MCD) at 16, Yum! Brands (YUM) at 18, and Panera (PNRA) at 26. Chipotle also does not pay a dividend which was a concern at first glance since even lowly Wendy’s/Arby’s (WEN) can pull that off.

Later that day I decided I wanted to do some further research. Originally the plan had been to find a Chipotle to eat at so that I could get a feel for what all the hype’s about, but these efforts came up lame. Then I thought to myself, how much would it cost to franchise a Chipotle. Then I remembered my teenaged short stint in fast food and thought better of it; and also read that one would soon be coming to a town 10 minutes from my house. So the taste test will have to wait, but through extensive interviewing I have found that they are more of a Panera than they are a Taco Bell. By this I mean that they are that strange new-school mix of fast food and sit down hoping that a good customer experience will justify higher prices. In this thinking it becomes apparent that there has been little franchising in my area given the rise of local restaurants like Surf Taco ( and Fins ( which appear to be the same thing with a surf jive; quality Mexican inspired food, only the freshest ingredients, ambiance aplenty, high philanthropy, and green thinking.

Wednesday morning: heavy news on the CMG news feed, they’ve opened their 1000th restaurant. But for Chipotle, it ain’t nothing but a G thang, their market cap now has them behind only McDonald’s, Yum! Brands, and Darden (DRI) in the restaurant industry having passed Wendy’s/Arby’s, Panera, and Burger King (BKC) among others. At this point it’s begun to dawn on me that CMG may be fairly priced. Just look at the earnings since they have gone public. The 2nd and 3rd quarters have historically been their best and they have just had a monster 1st quarter with EPS of $1.21. This leaves the forward P/E at around 25 which I would consider within an acceptable range, but estimates for this coming quarter are just under $1.40. The past 3 years they saw jumps by at least 22 cents and that was during a recession when chicken burritos were a dollar at Taco Bell (now they are over $2.50, forcing me to officially shun them). Additionally, it is possible that Chipotle has been innovating some things; today I read that profit margins for Chipotle are still only around 50% of McDonald’s. Of course McDonald’s has had much more time to perfect the craft of reducing costs, and they have the option of using less fresh goods, but McDonald’s held a large stake in Chipotle until 2006 and perhaps some things rubbed off. Also, from 2008 to 2009 Chipotle’s total revenue rose approximately 200 million but cost of revenue fell roughly 100 million (~10%). Based on these few factors I do not think that it would be unreasonable for earnings to be greater than $1.40 in the second quarter and then have an even greater surprise in third as more of these new stores turn a profit.

Looking at the CMG balance sheet you would see that there has been a stock piling of cash realized in 2009 and a lack of long term debt. These both bode well fundamentally. And of course retained earnings and capital surplus are killing it as well. One thing that would worry me is insider transactions and the fact that all are selling. Personally I don’t have as much a problem with it as most considering the poor economy, but it would be more reassuring if they were buying it up.

Bloomberg has 24 listed analysts for CMG, 14 buys, 9 holds, and 0 sells. The average target price for the 14 that have entered one is at $154, not too much higher than the current price. And the relative strength index is only at 53, lending credence to the fairly priced notion. I would have to agree with this as well. Chipotle would have to have an amazing year to reach an EPS of say $5.50, which would blow away the 14% growth rate, but is extremely feasible (actually I’d say it’s likely). However, if you use the forward P/E multiple of 25 you have a price in the high $130s and if you use the current P/E of 33 you’d get a price in the $180s. I know that this is very lenient math-wise, but let’s just assume a P/E of 30 is acceptable and you would have a price of $165, rendering Chipotle roughly accurately priced.

But fear not Chipotle holders for there is hope. Chipotle just opened there first location outside of America, in London (Taco Bell has just done this as well so things could get very interesting in the coming years). And with only 1000 stores there’s obviously room for growth. That coupled with the fact that eventually the global economy will normalize should yields positive outlook for CMG. Looking at the graph above you’ll see that they are well above their 200 day moving average and are also in the middle of channel which could be turning into a triangle. But I wouldn’t give too much creditability to the technicals; over the last year or so CMG has had what Recognia called bearish signals only to blow right by them. So if you’re looking for a longer term pick that’s currently not paying a dividend you could give Chipotle a look, but definitely pick your entry points wisely, perhaps under $147 if available.


No comments: