Is Chipotle Ready To Take Off Again?

| About: Chipotle Mexican (CMG)

Chipotle (NYSE:CMG) was once a sweetheart to Wall Street. The company used to enjoy a status currently enjoyed by likes of Amazon (NASDAQ:AMZN) and Facebook (NASDAQ:FB) where the fundamentals didn't matter, and the stock price looked like it could just keep going up forever regardless of financials. After moving from $100 in 2010 to $442 in 2012, the stock price crashed down to $235 after the company failed to impress the investors two quarters in a row. All of a sudden, the company found itself in that uncomfortable place where the fundamentals actually mattered. In October, when Chipotle was trading for $235, I suggested that the company was finally in the "buy" zone and bought some shares at $250. In November, I also said that Chipotle would be one of the companies to benefit from a possible Santa rally toward the end of the year. Since bottoming in October, Chipotle has appreciated by 36%. Yet, the company might still have some more upside left in it.

Chipotle's trailing P/E is 35 and forward P/E is expected to be around 30. This might sound expensive to many investors who got used to low P/E ratios in the last few years. Interestingly enough, there are some people who even think Apple is expensive with its low P/E of 10 (or 8 after excluding cash). While P/E is an important metric for valuation, it is not the only metric out there and there are many ways to determine whether a company is expensive or not. Also, not all companies in the market are "value plays." Some companies are "growth stories," which means they can handle a higher P/E ratio as long as the P/E ratios aren't ridiculously high like Amazon or Facebook. Also, companies with low or no debt can handle a higher P/E ratio because they don't have to spend a large portion of their income for servicing debt.

Let's take a look at Chipotle's latest numbers, which were announced earlier this week. In 2012, the company generated $2.73 billion in revenue, up from 2011's $2.27 billion by 20.26%. While some of this revenue growth was achieved by price increases, it is still impressive. Net income was up from $215 million to $278 million, which signifies an increase of 29.30%. The company's profit margin jumped from 9.5% to 10.2%. Chipotle now has $322.55 million in cash, $27 million for pre-paid expenses and $150 million worth of investments. The company's total assets are worth $1.67 billion, up from $1.42 billion last year. The company's debt totals a negligible $3 million. The company's debt-to-equity ratio is as close to zero as it gets.

Now we are looking at a company that continues to grow in double digits, has some cash and other assets in the bank, lacks debt and we see a company that can afford a P/E ratio more than many of its peers. Despite that many analysts have reduced their earnings estimates for the company in the next few years, they still think the company's growth story is intact. Chipotle is expected to earn $10.29 this year, $12.61 next year, $15.89 in 2015 and $17.99 in 2016. We are looking at more than 100% of earnings growth in the next five years considering Chipotle earned $8.75 per share in 2012. This is still solid growth and it's unfair to expect Chipotle to enjoy the same P/E ratio as those companies that see growth rates like 3-5% per year.

Chipotle still has a lot of things to accomplish and a lot of room to grow if things are executed nicely. The company has very little existence outside of the U.S., which provides it with a lot of room to expand once the growth in the U.S. slows down considerably. Of course the company has to work on a few issues. First, it needs to have a better control on food supply prices, which can be very volatile at times. Also, the company has to do a better job of marketing outside of the U.S. Usually, many brands become "big" in the USA before they move to Europe and elsewhere, and by the time they move to other countries, the brands are already established and recognized by the people in those countries. For example, McDonald's (NYSE:MCD) waited until 1967 to open its first store outside of U.S. (in Canada). It took McDonald's another 10 years before it opened a number of restaurants across Canada. Similarly, the first McDonald's restaurants surfaced in Europe through the 1970s. Would McDonald's have the same success if it rushed to open new restaurants in Europe before establishing itself in North America first? I highly doubt it. Basically, whatever becomes "cool" in the USA becomes "cool" in the rest of the world, but it takes time. Once Chipotle establishes itself as a strong brand in the USA, its restaurants in other countries will see better results than they are right now.

Chipotle will continue to see considerable growth in the years to come but the company needs to be a little patient and work on its execution outside of the USA. As the company works on this, the stock price will start to take off over time.

Disclosure: I am long CMG, MCD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.