Why Chipotle Will Sizzle To $600

Apr.16.14 | About: Chipotle Mexican (CMG)

Summary

The stock is down 15% from its 52-week high.

With shares trading at around $545, the stock should regain its $600 mark on the assumption that the company can produce 20% long-term growth in free cash flow.

The company continues to build on its recent achievements to drive better comps to deliver the level of profitability that investors have come to expect.

Making a case for why a dominant growth story belongs in a value investor's portfolio is not easy. This is even though the company's fundamentals support the returns on that investment.

While Chipotle Mexican Grill (NYSE:CMG), whose shares have doubled over the past couple of years, fits the category of a strong growth stock, value-oriented investors can still benefit from the company's improved financials. The company has built itself into a leading fast-casual restaurant that's posting strong growth and above-average margins.

And when compared to value plays like Yum! Brands (NYSE:YUM) and McDonald's (NYSE:MCD), Chipotle's 9% growth in same-store sales suggest that concerns about weakening profitability and management's aggressive growth plans have been overdone.

Notable detractors like Jeff Gundlach of Doubleline Capital and hedge-fund superstar David Einhorn, who famously predicted that Taco Bell would kill off the company, have been wrong. On Thursday, Chipotle will look to extend its streak of earnings beats and demonstrate why it has one of the best management teams in any sector.

Although investors appear a bit anxious, the Street is broadly optimistic ahead of first-quarter results. Analysts expect a 20% jump year over year in earnings. The consensus estimate is $2.82 per share, which up 47 cents from earnings of $2.35 per share a year ago.

While estimates have remained consistent over the past 30 days, expectations have inched up 2% since the January quarter. For the fiscal year, analysts are projecting earnings of $12.91 per share.

By contrast, Yum! Brands, will report earnings on Tuesday, April 22. Analysts are expecting earnings of 84 cents per share, which will be down 20% from last year's earnings of 70 cents per share.

In terms of Chipotle's revenue projections, the Street will be looking for $873.7 million, which is also 20% higher year over year. Last year, Chipotle reported revenue of $726.8 million. For the year, revenue is projected to come in at $3.80 billion, which will be higher year-over-year by 18.3%.

The company has enjoyed steady earnings increases spanning eight quarters. Equally, and perhaps more impressive, is the fact that Chipotle has averaged 12% net income increase in the last four quarters, including a 22% surge in the January quarter.

Likewise, revenue has risen in each of the previous three quarters, including a 16% jump in the January quarter. Chipotle has benefited from strong growth from a solid business model that focuses on a few ingredients to produce an array of menu items that customers enjoy.

That and Chipotle's unique food culture allows management several options to do things in ways that other quick-service rivals like McDonald's and Yum! Brands have been unable to duplicate.

What's more, Chipotle's management is not letting its foot off the pedal. The company continues to build on its recent achievements to drive better comps to deliver the level of profitability that investors have come to expect.

Chipotle has developed the sort of leverage that has allowed management to raise the prices on its menu to offset rising costs of beef and chicken. Contrary to bearish theses, this has had no adverse effect on the company's growth. Management also continues to demonstrate solid cost-control measures to bring efficiency to the business.

Surprisingly, despite Chipotle's recent successes, investors are anxious about holding the stock ahead of Thursday's report. Investors who are paying for growth today want assurances that margin and comps will continue to move in the right direction. The stock is down 15% from its 52-week high, and I see Chipotle as a strong buying opportunity.

Until there are meaningful signs of slowing down, I continue to expect strong double-digit growth from Chipotle. With shares trading at around $545, the stock should regain its $600 mark on the assumption that the company can produce 20% long-term growth in free cash flow.

This is more aggressive than management's guidance. But given Chipotle's strong same-store sales results, which trumps both Yum! Brands and McDonald's, 20% cash flow growth is achievable for all of 2014.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Wall Street Playbook's financial sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.