Chipotle Mexican Grill: Still Proving The Shorters Wrong

Jan.10.12 | About: Chipotle Mexican (CMG)

It’s just a week into the new year and it appears that restaurant stocks have carried their momentum into 2012, looking to continue their run of tremendous gains. McDonald’s (NYSE:MCD) traded above the $100 mark for a few days and with some market luck will use this as new support. A year ago McDonald’s was trading at $75 and there were worries about increasing costs. The first cost was that of the Chinese labor force and the second was the cost of beef and other ingredients. Ultimately neither stood a chance of slowing down McDonald’s as it continued to develop new lines (McCafe, smoothies) and generate revenue through excellent margins.

Last week also marked a new 52-week high for the most exciting restaurant play, Chipotle Mexican Grill (NYSE:CMG). In a year’s time the stock has shot from $220 to over $345. Chipotle has been frequently cited as a heavy short candidate over the last few years only to disappoint, and it appears that their growth story still has room to run for several reasons. I would not normally begin an analysis with a graph, but in the case of Chipotle the chart is too telling to save for later.

Click to enlarge

This is a two-year chart with 50 and 200 day simple moving averages. Over this time Chipotle has increased 250% in price and as you can see, the stock price has not come close to the 200-day moving average in quite some time. More importantly there is a moderately steady incline with no dramatic pull backs. Furthermore, there are not any major jumps upward either, which means that generally good earnings are expected and met, with strong, but expected guidance coming with it. (As an FYI, Chipotle’s next earnings comes on February 1st.) So even though at first glance the stock may appear overpriced and risky, from the perspective of the graph, its price movement is warranted and relatively predictable.

Chipotle has a premium product at moderate prices with steady demand. You cannot really ask for more when looking at the underlying business of a stock. As readers likely know, Chipotle is best known for their “Food with Integrity” slogan, which Cramer has pushed in recent weeks as a long-term trend. They do not really fall into the traditional fast food category and I prefer to refer to them (and Panera (NASDAQ:PNRA)) as fast-casuals; a fast food/sit-down restaurant hybrid. In both cases consumers tend to sacrifice a longer wait time for better, healthier food, albeit slightly more expensive; which brings me to my next point.

Chipotle often takes a lot of flak over the costs of their meals and this is wholly unjustified for the following reason. Chipotle does not franchise, ergo they own these restaurants. This means that they are responsible for their failure, and will therefore take protective measures to ensure this does not happen. In short, they only open locations in areas with a clientele that can and will support it. Hence, there are close to a dozen in lower Manhattan and in other major cities but few in risky rural and suburban areas. To Chipotle its basic economics: with a hard price on its product, locations will only be opened where demand exceeds supply, which explains the lines.

Chipotle’s books are almost as enticing as their burritos. A quick glance over their quarterly data and you’ll see steady inclines in earnings, revenue, cash, and current assets. In addition, Chipotle does not carry much debt and retained earnings have been piling up. If and when it is decided that the growth prospects are not what they used to be it is very possible that Chipotle will transition nicely into a dividend paying stock.

Speaking of growth prospects; Chipotle is operating around 1,100 restaurants with more in the works. In the last two years, 100 locations have opened and the first restaurant overseas (London) was opened. Again, these are not franchised, so the timing of restaurant growth is somewhat limited as training and such comes from within. Initially that may sound detrimental to growth, but the counter argument is that each restaurant will be opened in an area primed for success. It also means that there will be more such areas available. For comparison’s sake there are 1,500 Panera Breads and that figure is rising too.

My last point as to why Chipotle still has room to run is that they have no true competitors. One could make an argument for Qdoba, which is owned by Jack-in-the-Box (NASDAQ:JACK), but there are far fewer of them (around 500) and they franchise, so they are not run as efficiently (margins). Also, at least in my geographic region, Qdoba lacks the flair that Chipotle has, both in name, service, and food.

The next argument would be for fast food, but as stated above, Chipotle falls outside of this category. It is easier to think of Chipotle as a sit down lunch and dinner establishment, whereas you’d be much more likely to eat fast food while in your car. And Chipotle does not have to compete with traditional restaurants, which have much longer visits and are generally more expensive. Panera and other small delis are really the only options that come close to the casual nature that Chipotle offers, but the food is very different. Based on the foregoing, I believe it is safe to say that Chipotle still has plenty of room for growth before it cools off.

Disclosure: I am long MCD.