Chipotle: Almost There

| About: Chipotle Mexican (CMG)

Summary

Incredible growth waiting to be had.

This story has been seen before.

Incredible balance sheet.

In the last several months, I have read a number of compelling articles about Chipotle Mexican Grill (NYSE:CMG) right here on Seeking Alpha (SA). A number were bullish, a number were bearish, and everyone who eats there seems to have an opinion. It's important to take notice: people are passionate about CMG.

Looking back to a number of the articles I have written since joining SA, most have been either a value approach and a long term buy, or in a few cases, a very clear short selling thesis. CMG having been IPO'd by McDonald's (NYSE:MCD) in 2006 is still a growth story - a solid growth story.

As a value investor, I try to value things in terms of multiples. CMG had always proved very difficult, but no time is better than the present. What I found was very compelling: it is a stock I want to buy - a lot of.

Before we get into the financials of the company, let's take a look through the Michael Porter goggles and ensure we're comfortable with the results. Porter's 5 forces are: threat of new entrants, threat of substitutes, bargaining power of buyers, bargaining power of suppliers, and finally, industry rivalry.

Threat of New Entrants

Currently, CMG operates approximately 2066 restaurant location offering very fresh burritos, tacos, and salads. As a result of their scale and product offering it is possible but not a cakewalk to begin competing with them. I believe they achieve economies of scale in purchasing from suppliers and distribution, essentially discouraging new entrants from coming in. Currently, there are a number of competitors, but few are as well known as CMG.

Threat of Substitutes

Depending on your dining preferences, this can be very subjective. It is easy to find something else to eat, either less or more costly depending on how much compromise you are prepared to make. CMG does however offer the freshest foods in an era of "health conscious" consumers. There is a perception of product differentiation, but I think it is actually minor.

Bargaining Power of Buyers

Given the scale of its operation and distribution, CMG has shown from past actions, the bargaining power is not in the hands of the consumer, but they hold a lot of influence. A number of price increases were previously passed on to consumers. Given the product was of quality and delivered on time it had negligible effect on revenue and profit. CMG continues to get consumers in the door. We will discuss customers at a later time.

Bargaining power of suppliers

As CMG is a very big company, they have a considerable amount of power. Previously spun off from McDonald's, CMG is well aware of how to obtain the best price and distribution from their suppliers. Advantage CMG.

Industry rivalry

In the past 20 years, we've seen burger wars and as a result a very happy consumer. I think with the freshness of their product and (arguably) their first mover advantage, CMG will need a very significant and prolonged rivalry within the entire fast food industry to be significantly affected.

From the 5 forces, we can figure out the customer has the power to go elsewhere but instead chooses CMG. Unlike a car depending on gasoline (you cannot easily switch it to diesel), every one of CMG's client can easily walk across the street. CMG has done an excellent job in delivering for their customers every day for the past 10 years - or almost. In the past year, there has been a major issue which has driven customers away in droves and the stock price has taken a dive as a result.

I'm very excited a about this opportunity.

About 15 years ago I was in business school reading a book entitled Fast Food Nation, which was later made into a movie. The premise was simple: this is everything wrong with the fast food industry and everyone should hate the fast food industry (especially the dominant player). Now 15 years later, the stock of McDonald's has performed fantastically and people greatly enjoy eating at McDonald's. Just this past weekend, Mr. Trudeau (the Prime Minister of Canada) ate at McDonald's, it was in the news. (Yes, this is news in Canada).

Looking again at the issues of CMG, I believe consumers today have shorter memories than 15 years ago and they will be back in droves. CMG has continued to build more stores to accommodate them. Let's take a look at the store count of CMG (at the end of each year) and their effects on total revenue and profit. All information was retrieved in CMG's annual and quarterly reports.

2010

2011

2012

2013

2014

2015

2016 Q1

# of Stores

1084

1230

1410

1595

1783

2010

2066

% Increase from Previous year

13.47

14.63

13.12

11.79

12.73

2.79

Annual Revenue (in Thousands)

1835922

2269548

2731224

3214591

4108269

4501223

% Increase from Previous year

23.62

20.34

17.70

27.80

9.56

Annual Profit (in Thousands)

179558

214945

278000

327438

445374

475602

% Increase from Previous year

19.71

29.34

17.78

36.02

6.79

Click to enlarge

Until the company "stubbed their toe" at the end of 2015, we can see the incredible propulsion forward of each new restaurant. Until 2015, revenue and profit increased at a greater rate than the store openings (as a percentage).

In addition to the CMG stores, the company is also testing their approach to ShopHouse (14 locations) and Pizzeria Locale (4 locations). Potentially, one of these 2 brands could lead to the second dance for Cinderella. There could be incredible growth here for yet another 10 years or more. Let's look at the multiples of P/E and P/Revenue. The 29.35 Shares outstanding for 2016 are as of the end of Q1.

Share Price

Shares Out.

Price / Earnings

EPS

High

Low

High

Low

Year 2016

542.50

384.77

29.35

Year 2015

758.60

478.00

30.58

50.24

31.66

15.10

Year 2014

697.90

472.40

31.03

49.39

33.43

14.13

Year 2013

550.30

266.00

31.03

53.12

25.68

10.36

Year 2012

442.40

233.80

31.09

50.56

26.72

8.75

Year 2011

347.90

213.10

31.25

51.46

31.52

6.76

Year 2010

262.80

86.00

31.07

46.60

15.25

5.64

Year 2009

98.70

46.50

31.48

24.99

11.77

3.95

Year 2008

150.00

36.90

32.19

63.56

15.64

2.36

Year 2007

155.50

54.60

32.81

73.00

25.63

2.13

Year 2006

67.80

40.90

32.54

52.97

31.95

1.28

Share Price

Price / Sales

Sales/Share

High

Low

High

Low

Year 2016

542.50

384.77

Year 2015

758.60

478.00

5.15

3.25

147.18

Year 2014

697.90

472.40

5.27

3.57

132.41

Year 2013

550.30

266.00

5.31

2.57

103.59

Year 2012

442.40

233.80

5.04

2.66

87.84

Year 2011

347.90

213.10

4.79

2.93

72.62

Year 2010

262.80

86.00

4.45

1.46

59.08

Year 2009

98.70

46.50

2.05

0.96

48.23

Year 2008

150.00

36.90

3.62

0.89

41.38

Year 2007

155.50

54.60

4.70

1.65

33.10

Year 2006

67.80

40.90

2.68

1.62

25.29

Click to enlarge

It is clear from past multiples, the profit and sales per share have increased substantially as have the multiples. Valuing this based on multiples alone is difficult given the growth of the company. The 2017 earnings per share estimate (from Value Line) is $16.40 (2015 EPS were $15.10 according to Value Line). At $400 per share, this would mean 24.4 times forward earnings (if I am patient another 6 months).

Let's go over my rationale on this one. I'm treating 2016 as a complete wash and looking forward to 2017. Assuming the 2017 projections are accurate (that's a big assumption, I know), the stock at its current price would trade at 24.4 times earnings, telling us the security is potentially undervalued or the estimates are wrong. Given Q1 sales and a moderate loss for CMG, we will very soon find out when the company reports Q2 2016 earnings on July 19th, just how fast customers are coming back into the restaurants. Long term, my opinion is they are coming back. Short term, we'll have to wait and see when earnings come out.

A few other things

CMG does not pay a dividend but has re-purchased shares in Q1 2016 totaling $583.8 Million. I think this will be beneficial over the long run.

According to Note 4 in the 2016 quarterly report, another $68.4 Million was spent on share buybacks (after March 31st, 2016).

CMG does not have any long term debt - one less thing to worry about.

The Canadian (13 locations) and international expansions (12 locations) have only begun.

ShopHouse & Pizzeria Locale are the growth waiting in the wings. This could translate to a high multiple for a long time to come (once the growth of Chipotle Mexican Grill restaurants slow.

The return on equity (ROE) has been very consistent since 2011. See below.

Profit Margin

Asset Turnover

Financial Leverage

Net Income / Sales

Sales / AVG Total Assets

AVG Total Assets / Average SE

ROE

Year 2015

476

4501

2626

4501

2626

2070

0.1057

1.7140

1.2686

0.2297

Year 2014

445

4108

2268

4108

2268

1775

0.1084

1.8112

1.2777

0.2509

Year 2013

327

3215

1839

3215

1839

1392

0.1019

1.7480

1.3210

0.2352

Year 2012

278

2731

1547

2731

1547

1145

0.1018

1.7655

1.3510

0.2428

Year 2011

215

2270

1273

2270

1273

928

0.0947

1.7822

1.3729

0.2317

Click to enlarge

Summary

Looking at CMG, it's hard to put all the pieces together given the recent problems they've had. In this article, I've tried to go through them one at a time and share my bullish case for CMG. At the core of this bullish thesis is the belief that customers will come back and in droves. It also depends on the 2016 earnings being a complete wash and the 2017 earnings being excellent. I think these things go hand in hand. Once customers come back, earnings will stabilize and CMG will finish 2016 with positive earnings and continue opening more locations, leading to greater profitability throughout 2017. A company spun off from McDonald's is not one I wish to bet against.

Although some will argue (I am certain, and I appreciate your comments below), the fundamentals and the financials line up and are very compelling. Price target within 18 months: $650 or 62.5% increase from here.

Disclosure: I am/we are long CMG.

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.