We believe Chipotle's (NYSE:CMG) Q4 ER affirms our thesis that CMG is uninvestable at the moment. We believe the current valuation is stretched considering all of the risks and ambiguity attached to the near- and long-term growth story. We further believe the current valuation does not properly account for the risks associated with a pending federal criminal investigation which is broadening, as well as the hugely negative January comps. We believe shares should trend downward in a 6-12 month time frame.
We released an earnings preview in which we expected January comps to trend along the -15% to -20% range, representing improvement from December comps due to the lack of negative announcement catalysts in January relative to December. January comps, however, worsened from December to fall 36%. This is especially indicative of sustained customer churn because there were no additional reports of food-borne illness in the quarter. Traffic trends should improve throughout the quarter, with February and March comps being easier than the tough January 2015 comps. The CDC announcement that the investigation was over should also help improve traffic, as well as significant ad spend from the company to recapture customers. The negative acceleration in comps from -30% to -36%, however, indicates to us that it will take a good amount of time and money until CMG regains customer trust. We see Q1 comps coming in around a -20% to -30% range.
We are further bearish on restaurant-level operating margin performance throughout this year, as the company has commented that costs associated with its new food safety program will weigh on operating margins this year until sales trends begin to recover. This means that in Q1, we are looking at significantly compressed margins on significantly negative comps. Given management's discussion of how comps affect the restaurant-level operating margin, we see Q1 restaurant-level operating margin somewhere in the low teens (given our Q1 comps expectation of -20% to -30%).
We do not like the current stock price because we do not believe that low visibility, continued negative sales trends, and significantly lower operating margins are baked into the current valuation which remains shockingly rich even on an ex-cash basis.
The company reported net cash of roughly $248 million in the ER, and on around 31 million shares outstanding, that is $8 in NCPS. Striping that out from the current $460 quote, we get an enterprise value of $452 per share. This means the stock is trading around 35.3x fiscal 2016 EPS estimates of $12.80 (ex-cash multiple), and this multiple is on 25.6% EPS growth pre-E. coli scare (first nine months 2015 versus first nine months 2014). The stock is currently trading at a healthy premium to its pre-E. coli scare earnings growth.
This stretched multiple is also true for free cash flow. The stock's ex-cash FCF multiple (~33x) is more than 7x larger than its normalized pre-E. coli scare FCF Y/Y growth (4.5% from the first nine months of 2015 versus the first nine months of 2014). What we see across important operating metrics for the company is that the stock is trading at a premium to even its pre-E. coli scare growth.
This is especially concerning considering the pending federal criminal investigation which is broadening. CMG announced it was served with another subpoena on January 28 that broadened the scope of the previously announced criminal investigation by the US Attorney's Office for the Central District of California. The new subpoena requires CMG to produce documents and information related to company-wide food safety matters dating all the way back to January 1, 2013. Management didn't provide much color on this issue on the call, but our prior research indicates some suspicious activity at the Simi Valley location. If anything turns up criminal here, the road to sales recovery for CMG could take much longer than currently projected by analysts.
This risk is not baked into the current valuation, which is already overstretched even ignoring this risk. At best, we think this stock should trade at parity to its pre-E. coli scare growth, and that implies further downside from the current price.
Disclosure: I/we 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.