Several months ago I said that Chipotle Mexican Grill (CMG) was overpriced, and since then shares have risen by almost another $100 so I figured it was a good time to revisit this one. While the company's revenues continue to rise at a rapid pace, it is extremely hard to justify the current valuation of the stock. At some point, growth will slow down a little, and the P/E of over 46 times TTM earnings will look even more overvalued than it does now.
The current state of Chipotle
Chipotle has grown very rapidly over the past decade, and has done an excellent job of capitalizing on the increased dietary awareness trend that is growing in the U.S. It seems that Chipotle got into the "fast casual" business at the right time, and consumers love the idea of food whose ingredients they can pronounce that is served at fast-food speeds.
Chipotle currently has more than 1,430 restaurants in the U.S., an astounding number considering that there were only 227 at the end of 2002 and 1,084 at the end of 2010. This means that the company has grown at an average annual rate of 20.5% for over 11 years and has not yet slowed significantly.
The question is: how long can this last? History has shown that growth rates of over 20% are generally not sustainable for a long period of time. Eventually, growth will begin to slow as the company's restaurants get closer to one another, making further expansion less efficient. This is a matter of "when", rather than "if", but I feel like growth will slow down (not stop, just maybe slow to the 10-15% range) a lot faster than the market seems to think.
The numbers: the good
Of course the company's numbers from the past decade or so look very impressive…that is to be expected. Consider how Chipotle's revenues have grown, for instance:
What is extremely impressive to me is how Chipotle has managed to grow their sales per store over this time period, in addition to growing the number of stores itself. Based on the number of stores open at the end of 2002, this implies that each store generated about $1.4 million in annual sales, which is impressive enough for a quick-service restaurant. Using the 2012 numbers, each store achieved sales of about $1.9 million, about 36% more per store than the company was producing a decade before.
Earnings growth has been equally impressive, with the company first achieving profitability in 2004, and growing their profits during every year since, including the tumultuous recessionary years of 2008-09. The consensus of analysts that cover the company seem to believe the earnings growth will continue. Chipotle is projected to earn $10.59 this year, rising to $12.93 and $15.70 in 2014 and 2015, respectively, for a 3-year average annual earnings growth rate of 21.5%. Before I go just a bit negative on you, I will say that I wholeheartedly agree with the analysts' projections and believe that a 20% annual growth rate will be sustained for at least the next few years. All of the targets set are certainly achievable.
What would be a fair valuation?
As it often happens when you have an incredible long-term growth story like this, Chipotle's share price has gotten a little ahead of itself. Now, growth stocks understandably trade for a premium, so they can be tough to value relative to their slower-growing peers. However, there is one investing rule that I have lived by when it comes to growth stocks that has served me well.
Basically, take a company's average annual growth rate that is projected for the next 3 years (21.5% in this case) and double it. So, in Chipotle's case, 21.5 times 2 equals 43. The TTM P/E should be no higher than this number, or else too much growth is priced into the stock.
So, even without considering the fact that I don't think that the growth will be sustained for much longer than a few more years, Chipotle is pricing in way too much long-term growth with its current 46.75 TTM P/E ratio. A "fair" valuation by my "double growth" rule would be $408.08, about 8% below the current price. Even if it were to pull back to this level, I wouldn't jump in. Remember, we want bargains, not stocks that are simply "fairly priced."