Chipotle Has Strong Competition Now, No Longer Conviction Buy

| About: Chipotle Mexican (CMG)


Chipotle Mexican Grill (NYSE:CMG) was one of the first restaurants in the fairly new "fast and casual" dining industry. This sector of the restaurant industry offers the convenience of fast dining with the quality and experience often found in fine dining. CMG uses quality ingredients, focuses on unique interior design, and insists on friendly employees bringing its customers the best of both worlds. These Mexican food restaurants offer primarily burritos, tacos, burrito bowls, and salads. In December 2012 CMG held 1,410 restaurants in the United States, 5 in Canada, 1 in London, England, and 1 in Paris, France. This company was founded in 1993 and its headquarters is now in Denver, Colorado.


CMG has been an innovative company from the start. At this time, we see the company as mostly fair valued. Despite the growth prospects for CMG, the company has some competition and margin issues that we believe stand in the way of the company's potential upside. CMG is experiencing more and more competition from other restaurants that are beginning to appear in the "fast and casual dining" market as well as fast food restaurants that are offering products similar to CMG. In recent press releases, CMG has announced new projects that show its continued dedication to innovation. Our "Hold" rating is due to the fact that CMG is a healthy company that is fair valued for its past and future growth potential.


Valuation -

CMG has a current PE of 36.7 and future PE of 26.1. CMG is valued higher than the industry average of 18.9, a first indication of overvaluation. This is a popular company that is growing and for which investors are willing to pay a premium. Is this high valuation justified for the 2013 fiscal year?

When comparing CMG's 2011 Q4 with its recently ended 2012 Q4, we see that its net revenue increased 17.2% to $699.2M. Its net income increased 6.8% to $61.4 million. During this quarter, CMG opened 60 new restaurants. Papa Johns (NASDAQ:PZZA) saw a 19.9% increase in net revenue during Q4 to $367.3 million. PZZA's net income increased by 24% to $17.4 million. PZZA opened 134 restaurants during this time period. Another competitor, Einstein Noah Restaurant Group (NASDAQ:BAGL) saw net revenue decrease by 3.9% to $110.6 million. BAGL opened 20 restaurants during Q4. PZZA has the highest increase in net revenue while CMG is close behind. PZZA also had a large increase in net income, beating CMG by almost double. BAGL is the weakest company in this comparison with very slight increases in net revenue. PZZA also opened over twice as many new restaurants as CMG.

In comparing the full fiscal years we see that net revenue increased in 2012 20.3% to $2.73 billion. CMG's net income increased 29.3% to $278.0 million. During the 2012 fiscal year, CMG opened a total of 183 new restaurants. PZZA saw a net revenue increase of 10.2% to $1.3 billion for the 12-month period, and also saw an increase of 12.8% to $61.7 billion for 2012. During this 12-month period, PZZA opened 280 new restaurants. BAGL saw net revenues for the fiscal year increase 0.8% to a record $427.0 million. Its net income increased 25.2% to $16.4 million. BAGL opened 55 new restaurants in 2012. CMG has stronger numbers against its competitors for the full fiscal year thus showing reasons for its premium valuations over competitors in the industry. CMG beats the competitors firmly in net revenue increase and net income, again projecting a strong 2013 fiscal year. CMG has begun other projects like the Sofritas menu item, a catering option, and continued growing its ShopHouse Southeast Asian Kitchen restaurants, growth potential options we will discuss in the "Catalyst" section.

If we look at key ratios, CMG has an ROA at 18.0%, ROE at 24.3%, and ROIC at 24.2%. PZZA's ROA is 14.9%, ROE at 31.5%, and ROIC at 22.7%. Finally, BAGL's ROA is at 6.1%, ROE is 22.1%, and ROIC is 6.5%. CMG is the leader in ROA and ROIC, BAGL is again the weakest company while PZZA is a strong contender and has the highest ROE of the three companies.

All in all, CMG is a strong company that shows signs of healthy profits and growth. It has shown decent growth in the past fiscal year, but it seems to have tapered off during Q4. The strong valuations for the company are attractive, but competition could hit margins as well as growth potential moving forward.

Catalyst -

In recent press releases CMG has announced new innovative ventures for the company. Seven CMG restaurants in the San Francisco Bay area are offering what the company is call "Sofritas," a tofu option for its bowls, burritos, tacos, and salads. This could be a new selling point for vegetarian customers. CMG also recently announced that it is offering catering in the Denver area. Again, if this catering sector takes off, CMG could see huge growth and more increase in revenue. Since these two projects are only in the experimental stage we cannot yet count on future profits. What these initiatives show is that CMG is an innovative company that is concerned with remaining as cutting-edge as it has been since its conception. CMG also has two ShopHouse Southeast Asian Kitchen restaurants, one in Washington, D.C. and the other in Los Angeles. These restaurants are the Asian version of the Chipotle Mexican Grill where customers customize and watch as their meal is built from fresh, gourmet ingredients. This is another area the company shows growth potential. We believe this company is healthy and will remain that way, but with stock already valued high and growth projects in the very beginning stages we rate CMG at "Hold."

Economic Moat -

CMG's economic moat is in its overall product and the customer experience. As briefly touched on, before customers enter CMG restaurants and are greeted by modern architecture. They then watch as their food is prepared before them with partially locally grown and organic ingredients, a point that CMG makes sure to advertise. The experience is fast and convenient mixing the convenience of fast food with the quality of fine dining. There are few restaurants comparable to CMG in this regard although there are certain competitors like Piada, Qdoba, and Taco Bell that have clearly recognized CMG's uniqueness that customers enjoy and are trying to tap into this "fast and casual dining" market. Piada is an Italian take on the CMG "build your own" model. Qdoba is a different Mexican restaurant similar to CMG. And Taco Bell, although it is still fast food, has a line of Cantina items on its menu that resemble the CMG style of bowls, burritos, and chips & sides. In order to act against competitors these new projects like the Sofritas, catering, and the ShopHouse Southeast Asian Kitchens restaurants could help CMG strengthen its economic moat with more barriers to entry. CMG does not have the strongest economic moat but it is a unique company that offers a product and experience customers come back for.

Revenue and EPS Outlook -

During Q4 of 2012 CMG saw a 7.7% increase in its diluted EPS to $1.95. For the full 12-month period CMG's diluted EPS increased YoY 29.4% to $8.75. CMG's competitor PZZA saw a 13.8% increase in EPS in Q4 to $0.74 and a 19.4% increase during the 12-month period to $2.58. BAGL's EPS for the 12-month period increased by 21.8% to $0.95. For EPS we see similar comparisons as we did in net revenue and net income. CMG saw a large increase in EPS for the full year, but saw weaker numbers compared to PZZA for Q4. BAGL remains the weakest competitor in this comparison. CMG's EPS, currently at 2.58, is predicted to increase to 10.25 by December of 2013. PZZA is expected to move from 2.58 to 2.96. BAGL is predicted to move from its current EPS of 0.74 to 1.00 by December. Clearly CMG has the greatest potential for the current year.

Price Target Analysis

The following price target was configured through a 5-year projected discounted cash flow analysis. The model projects operating income, taxes, depreciation, capital expenditures, and changes in working capital. Using that information, we can project what the company is worth. We can then use that projection and compare it to current prices.

Here is how to calculate price targets using discounted cash flow analysis:

Step 1.

Project operating income, taxes, depreciation, capex, and working capital for five years. Calculate cash flow available by taking operating income - taxes + depreciation - capital expenditures - working capital.

2012 Projections

2013 Projections

2014 Projections

2015 Projections

2016 Projections

Operating Income


















Capital Expendit.






Working Capital






Available Cash Flow






Step 2.

Calculate present value of available cash flow (PV factor of WACC * available cash flow). You can calculate WACC, but we have given this number to you. The PV factor of WACC is calculated by taking 1 / [(1 + WACC)^# of FY years away from current]. For example, 2016 would be 1 / [(1 + WACC)^4 (2016-2012).

WACC for CMG: 7.00%






PV Factor of WACC






PV of Available Cash Flow






Step 3.

For the fifth year, we calculate a residual calculation. This number is calculated by taking the fifth year available cash flow and dividing by the cap rate, which is calculated by taking WACC and subtracting out residual growth rate. Residual growth rate is typically between 2-6%. 4% is average growth for industry. Companies with high levels of growth have higher residual growth, while companies with lower growth levels have lower residual growth. This is why higher growth companies tend to have higher PE ratios. We will give you cap rate.

Cap Rate for CMG: 2.00%


Available Cash Flow


Divided by Cap Rate


Residual Value


Multiply by 2016 PV Factor


PV of Residual Value


Step 4.

Calculate Equity Value - add PV of residual value, available cash flow PVs, current cash, and subtract debt:

Sum of Available Cash Flows


PV of Residual Value


Cash/Cash Equivalents


Interest Bearing Debt


Equity Value


Step 5.

Divide equity value by shares outstanding:

Equity Value


Shares Outstanding


Price Target


Profit/Value Industry Comparisons


Q1-Q3 2012

Q1 - Q3 2011

Operating Margin



Gross Margin



Return on Equity



In all three categories CMG has shown increases in profitability margins. YoY CMG's operating margin increased from 15.5% to 16.7%, its gross margin increased from 26.0% to 27.1%, and its ROE increased from 23.2% to 24.3%.

Let's compare with other companies in the same industry. BAGL's operating margin decreased from 5.8% to 5.7%, its gross margin increased from 19.2% to 21.2%, and its ROE increased from 16.0% to 22.1%. Yum! Brands Inc's (NYSE:YUM) operating margin increased from 14.4% to 16.3%, its gross margin increased slightly from 27.6% to 27.7%, and its ROE increased from 77.6% to 80.3%. Domino's Pizza, Inc.'s (NYSE:DPZ) operating margin increased from 15.7% to 16.8%, its gross margin increased form 28.5% to 29.9%, and it is not currently reporting any ROE. Lastly, PZZA saw an increase in operating margin from 7.1% to 7.3%, an increase in gross margin from 22.7% to 23.6%, and an increase in ROE from 27.3% to 31.5%. CMG, YUM, and DPZ all have similar movement in operating margin in the 15-16% range as the leaders of the market. DPZ has the highest gross margin, although CMG and YUM are again in the highest of the market close behind. YUM has by far the highest ROE then PZZA while CMG is in the middle.



Industry Average




Future P/E



CMG's current PE is 36.7, much higher than the industry's average at 18.9. The company's future PE is 26.1. CMG is presently valued high but that valuation is predicted to drop in the forward year.

BAGL is valued with a current PE at 19.7 and a future PE of 13.5. YUM has a PE at 20.8 with a future PE of 18.4. DPZ has a current PE of 26.1 and a future PE of 18.8. PZZA has a current PE of 23.5 and a future PE of 17.6. CMG is the highest valued company of this group with the highest future PE as well.


It is possible that the small projects CMG is testing could be very successful and the company implements a plan of action that sees results in 2013. Even without action taken on these ideas CMG could continue to see the type of growth it has seen in 2012, and in years past. It is also possible that the slight lull in Q4 revenues is indicative of the coming fiscal year and that CMG sees larger declines in profits in the forward year. Even though CMG is a unique company other companies in this industry are seeing a lot of growth like YUM, who saw a huge increase in ROE, and PZZA, who opened a large number of stores in 2012. CMG could see a rise in competition and a consequential decrease in its own profitability.

The Bottom Line

Overall we see that CMG is a healthy company that will maintain its profits, and we believe the company is fairly valued at its current share price. Our price target analysis projects CMG's stock price to rise over the fiscal year, but not to a point that justifies a "Buy" rating. We anticipate the stock value increasing by about 9.7% from its current value. Given its current PE and its Q4 revenues, we believe that this stock should be rated as a "Hold."

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The Oxen Group is a team of analysts. This article was written by David Ristau, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.

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