Chipotle Mexican Grill: A Great Company But Overpriced

Jan.30.14 | About: Chipotle Mexican (CMG)

2013 was a great year for Chipotle Mexican Grill (NYSE:CMG). Shareholders of the company must be quite happy as its share price moved more than 77%, from $301 per share to more than $531 per share. The company has also shown decent growth in its top and bottom lines.

Chipotle competes in the limited-service restaurant industry (also known as the fast food industry). Revenue growth in this industry is strongly tied to economic health, because disposable income and consumer spending affect demand for restaurant food. With the improving economy, fast food restaurant demand will increase. Revenue of the fast food industry in the U.S. is expected to increase from $199.45 billion in 2013 to $210.3 billion in 2016. Between 2010 and 2020, Global spending on goods and services is expected to increase by $12 trillion, an increase of 43%. Spending on food will account for about 10% of this growth. The United States will account for 25% of the world's spending growth through 2020. The growing fast food industry in the U.S. indicates that Chipotle should be able to maintain a state of growth in the U.S. market for many years to come.

Companies in the fast food industry can earn revenues from company-owned stores and franchise fees. Franchised operations account for about 10% of establishments, but 65% of revenue. Company-owned stores are more vulnerable to the economic environment, because the company has claims to restaurant profits or losses. All of Chipotle's restaurants are company-owned. If company-owned profits start to decline, Chipotle could look into franchising to cut costs. However, franchising would make it more difficult to maintain quality control.

Chipotle is a company that is very conscious of the value of its culture and brand, and makes strategic decisions to maintain and leverage this brand equity to grow in deliberate ways. Despite industry volatility and stiff competition, the company has shown substantial growth over the past five years. This has been achieved by increasing revenue in existing restaurants and by opening new restaurants around the U.S. As a result, Chipotle's growth has been entirely organic, and the company plans to continue this trend in the future. It has much room to expand domestically and internationally. With its high quality ingredients and expeditious made-for-me service style, Chipotle has developed a loyal customer base. It is generating solid returns from new stores and will continue to do in the future because new restaurants are typically led by well seasoned, trained personnel; well over 90% of restaurant managers having risen up from the crew ranks. The company's ability to effectively market its brand to attract new and existing guests will also help to maintain its strong return from stores and traffic trends.

Chipotle plans to open nearly 200 new restaurants in 2014. As Chipotle is a fast-casual restaurant, its real estate and labor costs are lower than traditional casual-dining operators. This will allow the company to keep opening new restaurants, attracting more consumers, and improving profitability.

Chipotle has many competitors in the industry. Some of the largest competitors in size and specialty are Yum brands (NYSE:YUM), Jack In The Box (NASDAQ:JACK), and McDonald's (NYSE:MCD). Yum and Jack have a little more diversity compared to Chipotle when it comes to revenue streams. McDonald's is not a direct competitor of Chipotle, but it attracts customers with its low-priced menu items. Some important key statistics of Chipotle and its competitors are given below.

CMG

YUM

JACK

MCD

Industry Avg.

EPS

9.87

2.39

1.14

5.55

n/a

P/E Ratio

49.82

31.65

43.72

17.43

113.28

Price/Book

10.33

13.76

4.49

6.17

11.21

Price/Sales

4.93

2.31

1.42

3.33

5.36

Dividend Yield

0.00%

2.20%

0.00%

3.40%

1.08%

Total Debt/Equity

0.00

127.48

78.45

88.94

38.28

Return on Assets

17.69%

14.20%

6.49%

15.33%

7.23%

Return on Equity

22.30%

46.78%

18.69%

36.68%

13.85%

Profit Margin

10.07%

8.48%

3.43%

19.88%

4.57%

Operating Margin

16.68%

15.40%

9.70%

30.30%

6.95%

Current Ratio

3.36

0.92

0.55

1.24

1.33

Click to enlarge

Chipotle seems to be overvalued using P/E, price-to-book, and price-to-sales when you compare to other competing companies in its industry. The company is also under-performing in its return on equity compared to the competitors. Another negative aspect of Chipotle is the fact that they are still growing and considered a growth company, resulting in them not paying a dividend. The industry average is a 1.08% dividend yield and in our situation we should possibly look for companies that are paying a dividend.

One positive aspect that stands out is the fact that Chipotle does not carry any long-term debt. Its liquidity position is also much better than Yum and McDonald's. With well capitalized balance sheet, Chipotle is poised to remain one of the restaurant industry's premier growth companies through the foreseeable future.

One business risk associated with Chipotle is that its restaurants are limited to the U.S. and Canada, with majority of operations concentrated in the U.S. Its international market is very small in comparison to Yum and McDonald's. Chipotle should use their resources to take advantage of opportunities in the international market. Although, the company still has a much room to grow in the U.S., it needs to move into emerging markets to continue this growth trend. International markets have promising opportunities for the company. By staying domestic, Chipotle is putting itself at a risk of economic, political and social fluctuations in the U.S.

Bottom Line

Chipotle is a great company and it is opening new locations at a rapid rate. It has a strong brand image, focused business model and deliberate growth strategies that will result in constant growth for the company. Chipotle is a fairly young company that has a lot of growth potential, but I feel that the market has it overvalued, so I recommend to hold this stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.