Jeffrey Gundlach is making headlines again with his call to short Chipotle Mexican Grill (CMG), according to Reuters. A little more than a year ago, he said to short Apple (AAPL) when it was trading around $610 and to go long natural gas (UNG) when it was about $2.50. Apple is now below $400 and natural gas is back above $4. Six months ago another famous investor, David Einhorn from Greenlight Capital, issued his short call on Chipotle shares as well.
Who Is Jeffrey Gundlach?
Jeffrey Gundlach is the founder of DoubleLine Capital, the fastest-growing mutual fund startup ever. Barron's proclaimed him the "King of Bonds" and he told them:
Look, I have a gift, or some would say a curse, of being able to have stunning insight into the reality of markets and the economy. I don't often know where my ideas come from. Maybe it's the fact that I'm obsessively regimented in my analysis, borderline autistic. But whether it's bond selection or asset allocation, we can do it better than just about anybody around.
Prior to launching DoubleLine, Gundlach and his team managed 70 percent of Trust Company of the West's (TCW) asset base. He told Businessweek that what makes him unique is:
I can still do about 7 percent in a world of 2 percent. You stress-test your portfolio constantly. You think about it and analyze it to death. Other people don't know how. I wish I could teach it to somebody.
Bear's Case On Chipotle
David Einhorn's thesis on Chipotle is that Yum! Brands (YUM) and its Taco Bell franchise are serious competitors to Chipotle. That their new "Cantina Grill" has the same quality as Chipotle, but at much lower prices. Einhorn also told the Value Investing Congress Conference last October that Chipotle is facing rising employee costs and increased food costs of corn and meat. Chipotle said in its most recent 10-K:
The cost of many basic foods for humans and animals, including corn, wheat, rice and soy oil, has increased markedly in some years, resulting in upward pricing pressures on almost all of our raw ingredients including chicken, beef, tortillas and rice, increasing our food costs. Food prices for a number of our key ingredients escalated markedly at various points during 2012 and we expect that there will be additional pricing pressures on some of those ingredients, including beef, chicken, pork, cheese and sour cream during 2013.
The biggest argument the bears make pertains to Chipotle's valuation. In the past five years, the company has grown revenue annually at the rapid pace of 22.8%, EBITDA at 33.2%, free cash flow at 133.6% and book value at 17.3%. However, sales are indeed now slowing. Last year Q1 sales increased 12.7%, Q2 increased 8%, and Q3 increased 4.8%. In Q1 of this year, comparable sales rose only 1%.
Bull's Case For Chipotle
Last year Chipotle posted record operating and EDITDA margins. According to Chipotle, it costs $800,000 to open a new location and their IRR on that investment is an amazing 71.5%. Overall Chipotle still has plenty of room for growth with having only 1,400 locations at the end of last year. 180 more locations are scheduled to open in 2013.
In looking at the stock, we see that its forward P/E is 29.19, which is very reasonable for a growth company. Operating margins are 17% and return on equity is 23.75%. On the balance sheet, there's $507.50 million in cash and no debt.
Of the analysts that follow the stock, 5 have it as a Strong Buy, 4 a Buy, 17 a Hold, 1 an Underperform, and 1 a Sell. Price targets on the stock range from $250 to $450 with $347.50 being the median target. UBS just upgraded the stock from Neutral to Buy.
First Quarter Earnings Better Than Expected
Boosting the bull's case is that Chipotle just beat expectations for first quarter earnings. Earnings came in at $2.45 per share versus expectations of $2.14 a share. The company also announced that it would speed up its international expansion and roll out its ShopHouse Southeast Asian Kitchen concept. Currently, Chipotle has only 12 foreign locations - six in London, 5 in Canada, and 1 in France. Its Asian-themed restaurant has only one location in Washington, D.C. Chipotle also announced plans to expand their catering business, which is expected to be 1.7 percent of sales in 2013.
Last year there were worries about Chipotle's growth slowing. The stock peaked last April above $440 and dropped to just under $234 after Einhorn's short call. The stock has rebounded since October and is back above $360. The company's latest earnings report I think gives the bull's ammo to be long. In the short term, I give the edge to the bulls. However, in regards to Gundlach, his Apple call started at $610 and the stock ran to above $700 first. An investor like Gundlach can take the long road and has the ability to withstand a trade going against him. In the long run, he may be right. Only time will tell, but first quarter earnings in my opinion support the bull case for Chipotle in the short term.