Back in 2012, when Chipotle Mexican Grill (CMG) was selling off in June and October after quarterly results, we published two pieces (here and here) arguing that the stock was still overvalued after the sell offs. Boy, it's not sweet to eat humble pie!. The stock has more than doubled from the October 2012 level of $250 to the current $533 per share.
But are things really getting better fundamentally or the market's irrational exuberance has pushed this stock from the "overvalued" territory to the "I can't believe it but it's even more overvalued" territory? Let us find out.
Valuation: Yes, everyone knew this was coming. So let us start with the most obvious but important point about valuation. Value investors raise a hue and cry when new companies with great prospects trade at a rich valuation. But here we are talking about the stock of a restaurant company founded in 1993 (public since 2006) trading at a PE of 54. Yes, 54.
If the number 54 doesn't sound scary by itself, try these:
- Chipotle is trading well above its 5 year average multiple of 39.
- The last two times the PE went above 50 were followed by the disastrous June and October 2012 quarters mentioned above.
- The industry's PE is around 25.
- S&P's PE is around 17, one third of Chipotle's. And before the bulls point out the earnings growth, Chipotle is expected to grow at twice the S&P's rate.
Earnings Growth: Chipotle is expected to grow earnings at about 20% per year for the next 5 years. That sounds impressive, but at a current multiple of 54, the future growth seems to be priced in already. This theory is given more validity with the current PEG standing at 2.5. Peter Lynch, one of the most well known advocates of growth stocks at reasonable prices, was a fan of stocks with PEG less than 1.
If you are a fan of looking at free cash flow [FCF] instead of earnings per share, the chart below should be interesting. Using the September quarter as an example, the 2011 FCF to 2012 FCF to 2013 FCF do not show any major increase. Comparing the YoY June 2012 to June 2013 FCF do not show much difference either. Overall, if you ignore the unusual March 2012 quarter FCF, there is not much of a spike elsewhere over the last 3 years.
(click to enlarge)
Price Target: Speaking of the growth prospects being priced in already, Chipotle's current price per share of $533 is already ahead of the $524 price target according to 25 analysts on Finance.Yahoo.Com. The table below shows the various price targets we collected from this link.
Even the most bullish price target is about 10% from the current price. Paying this high a multiple for a 10% return seems a bit too risky in our opinion.
Lofty Expectations: It does not take a lot for growth stocks to lose support from Wall Street as Apple (AAPL) evidenced for part of 2013. Apple's valuation of course never reached the heights that Chipotle has managed so far. But even at a far lower level of expectations, when Apple's margins were being questioned the stock lost favor quickly.
Are expectations too high for Chipotle? The table below seems to suggest so. Chipotle has failed to beat the estimates 2 out of the last 4 quarters. And one quarter barely came above estimates. The trailing twelve months earnings per share is $9.88 based on the table below. To put the 2014 earnings expectation into perspective, $12.96 is more than 30% from $9.88.
Competition: Finally, in spite of Chipotle's cult status, it is hard to look past the fact that this industry is filled with high profile competitors as well as local diners. For instance, YUM! Brands' (YUM) "Cantina Bell" menu is designed to collide head on with Chipotle's bread and butter. Even Chipotle's supposed push into quick-service Pizza chain has a formidable challenger in Buffalo Wild Winds (BWLD), as SA has covered here.
This is not to say that Chipotle will crumble entirely but the nature of this business makes it too hard to justify continuously lofty valuations in spite of some growth catalysts.
Conclusion: Chipotle does have a lot of good qualities like having no debt, unflinching institutional support (98.1% is owned by institutions according to Morningstar.com), reasonable growth prospects, and a loyal customer base. However, as shown by the points covered above, Chipotle's stock is way ahead of itself. This is not an advice to short the stock though, especially given the huge institutional ownership. But if you are thinking about buying the stock here, be advised that institutions can pull the rug quickly.
Actionable Bottomline for 2014: If you want to buy on the long side, wait at least till the PEG drops below 2, preferably 1.5. Else, stay on the sidelines as this stock is too dangerous to short for the average investor.