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Chipotle Mexican Grill (CMG) is an excellent company with a great business model and a great future. It has done very well in the past, due to its simplified understanding of its competitive advantage. This company should stick around for a while (this can be said with reasonable foresight) . However, continued interest in the company has rendered its stock too expensive. A reasonable person who invests for the long term is advised to wait out this enthusiasm and let the figures become more advantageous.

Listed below are some key metrics that decide a company's profitability over the long term:

Business Model: Good

The company focuses on using high quality ingredients, providing choices to the customer, and having a nice interior design than gives the restaurant an upper middle class ambiance. The food at the restaurant is tasty and appeals to different taste buds. So for instance, a regular burrito may be composed of sour cream, chilly or mild sauce, black beans, cheese, rice and guacamole. The tasteful ingredients sell better than the mostly one dimensional food offered at some other fast food chains.

The management recognize the huge marketability of this food and have started to venture into foreign markets.

Do they avoid unnecessary Risks? Not exactly.

It is very important for a business to know its unique advantages and shortcomings. This question, unfortunately, is not easy to answer for this company. Case in point is a new restaurant brand they recently launched, named Shophouse Southeast Asian Kitchen. It is yet to be seen whether this restaurant will prove to be successful.

To the company's credit, they've used the same tested logic while designing this brand. For example, they've emphasized similar interior decor, fresh quality ingredients, and a nice urban environment for the new restaurant. This restaurant may or may not be successful. Regardless, the point is that it may not have been necessary to experiment with a new brand this early. Especially since Chipotle's mexican restaurant is yet to appear (in significant numbers) outside North America. However, the company realizes that its main focus should be on the expansion of the Chipotle restaurants, and is very careful about opening Shophouse restaurants.

A debacle at Shophouse would certainly hurt the image of the company and will have taken vital attention off the Chipotle Mexican Grill restaurants. So the company does lose points on venturing into new brands while vast opportunities remain to expand its current business (For example: in the fast growing Asian Markets, where it has no restaurants). This does seem like a premature decision leading to unnecessary risk.

Management: Here to stay

The founder and CEO of Chipotle, Steve Ells is still in the prime of his life and could be expected to run the company for another 20 years. These 20 years will be the most important for this company, allowing it to become a truly international brand and also attract the best human capital.

Obstacles: Some

The company has no major obstacles in its path. The last 20 years of its presence have given it enough firepower to wade off competition from similar Mexican food chains. Qdoba Mexican Grille(JACK) is the company's main competitor, but Chipotle's better interior decor and a more family friendly atmosphere give it some advantage. Regardless, both companies have been around the same time, and serve quality food, and both could do well in the long term.

Liquidity: Could be better.

Even though the company doesn't need loads of working capital because its customers pay cash, it should consider increasing its cash reserves due to the nature of the business and the possibility of food inflation in the near future.

On paper, the company has good cash metrics, for example, the Current Ratio at the company is around 3, and it also has a low debt to equity ratio, of close to .33. Since the company has low debt, it may borrow money at relatively comfortable rates in the event of a crisis.

However, the company might need some extra reserves to protect against food inflation. For instance, the food, beverage, and packing cost for a year is 2 times the cash reserves. In the worst case scenario, with very high food inflation and higher interest rates, the company may need to borrow cash at higher rates to pay for raw materials. Or even worse, credit may not be available at all. Even though the company has reserves comparable to those at other restaurants, the company could consider increasing its cash reserves at the cost of a few points in growth rate. Another option the company could explore is increasing cash until the risk of inflation passes. Long term prosperity should not be sacrificed for short term gains.

The company's liquidity situation is not bad at all, however it would be even more attractive if the Working Capital were higher.

Price for stock: Very High.

The company has a PE ratio of 39. This is a very high number, regardless of the state of the economy, prospects of the company, and the PE ratio of the index. The stock valuation of a company is based on several variables. But the variable used by analysts who justify the high price for the stock ($366) is a high growth rate. This growth rate seems plausible on paper but a long term investor should leave room for error and mishaps.

The high price makes this excellent company a "Not Buy" for now, at least. An investor should wait for a correction in the market to bring the current PE ratio down.

Conclusion:

Even though the company has many positive attributes, namely an excellent business model, good management, a great future, low leverage, relatively comfortable liquidity; it is priced too high in the market, with a PE ratio of 39. Obviously, the market expects the company to grow rapidly, which may happen. However, the high price makes the stock less attractive, and thus it is not advisable for a long term investor to purchase it at this time.

Source: Chipotle Is Too Expensive!