There is no doubt that the restaurant sector performed unbelievably well in 2010. Below is a chart of four restaurant stocks year to date. Chipotle Mexican Grill (NYSE:CMG), the best performer of the four stocks listed below, will be the focus of this article.
McDonald's (NYSE:MCD), which reported a higher quarterly profit two weeks ago but slow December sales largely due to inclement weather, had many analysts worried about the restaurant sector as a whole. McDonald's management also stated that it would be forced to raise prices due to rising input costs.
Fast money trader Brian Kelly, to whom I think no one should listen for a number of reasons, decided that on the McDonald's report, shorting Chipotle Mexican Grill, which trades at a significantly higher multiple than McDonald's, would be the best way to play the restaurant industry. In these two links (here and here), he not only discusses the trade, but declares it as his first move the next day.
MCD has a current P/E of around 16, and CMG's P/E is around 40 after Tuesday's close. So naturally, from a simplistic, basic business 101 analysis of a stock, if rising input costs are going to impact margins, it makes perfect sense to short the stock with a higher multiple. And in college, on a multiple choice test, Mr. Kelly probably got this question right. However, he failed to ignore a flurry of stock specific reasons pertaining to Chiptole Mexican Grill that indicate one should not short the stock at this point in time.
1.) Upcoming Earnings Reports: CMG reports earnings on February 10th after the bell. CMG has knocked the cover off the ball the last three quarters, which causes a gap up in the stock followed by further momentum in the following trading days. The pattern for most high-flying stocks going into earnings this quarter has been a large run up into earnings, and then selling off on anything less than a perfect quarter. CMG had remained flat and underperformed on the year compared to the rest of the market and, therefore, was due for a possible bid before earnings. Kelly also failed to notice that YUM brands was reporting two days later (Feb. 3rd), and a good report from YUM could also help put a bid back into CMG.
2.) Fighting Cramer: CMG has been on Mad Money's host JIM CRAMER's buy list for a long time. Why does Jim's opinion matter? Obviously, his reputation precedes him because he has been calling winning stocks for a long time, so naturally you do not want to go against him. I learned this when I thought Netflix (NASDAQ:NFLX) was overvalued. Obviously, I could not have been more wrong. But if his track record is not enough, I urge all traders to look at a candle stick chart of ANY stock he mentions during the Stop Trading segment with Erin Burnett. The volume spikes immediately and will generally follow through with at least a 20 minute uptrend in the mentioned stock. One should not bet against a man with this much influence,
3.) Technicals Still In Tact: Below is a chart of CMG year to date, against the 100 day moving average. CMG had only sunk below the 100 day moving average once within the last year, at which point it managed to break through it the very next day. The overall trend is still from the bottom left to the upper right and shows no signs of a significant technical breakdown.
4.) Monster Volume, Responsible Growth, Haven't Raised Prices: The easiest way to see how this company is doing is to visit a restaurant. It is a rare occurrence when you can go to a Chipotle and not have to stand in a line of 20-30 people. However, with the efficient assembly line, they are able to move the customers through the line very fast.
Chipotle is also doing a fantastic job managing their expansion. CMG will not end up like a Boston Market, who through over expansion (at one point opening 1 new store per day), and menu diversification, dug their own grave.
CMG has a little over 1000 domestic locations and plans to open between 120-140 stores this year. CMG currently has little international exposure (one London store). The growth potential helps to justify the high multiple. I am also fairly positive that they have not raised their prices in quite some time (around a year). Just the slightest of price increases, given their volume and same store sales growth, would be enough to help cover some of these input costs.
Below is a five day chart of CMG following Brian Kelly's short trade. I would be interested to hear how he is currently managing it.
Disclosure: I am long CMG.