Chipotle Due For A Serious Correction

Mar.20.12 | About: Chipotle Mexican (CMG)

Chipotle has soared 57.8% in the past year and over 550% in the past 5 years, but because of a number of unforeseen headwinds Chipotle's stock is due for a serious correction. Its valuation has reached irrational levels and will be normalized after disappointing Q1 results.

Here's a look at why:

Growth estimates are too high

Chipotle added 150 new stores in 2011, bringing its total to 1230 from 1084 (they closed 4 locations). In 2011 they were able to grow revenue by 23.6% and achieve an increase in same store sales of 11.1%. For 2012 Chipotle is expected to increase revenue by 21.1%. If Chipotle adds 165 stores (high estimate), then it will have increased its number of stores by just 13.4% (vs. 13.5% in 2011), which means they will have to have exceptionally strong same store sales to hit analyst revenue targets.

Same store sales could be good in 2012, but there is no doubt that they will not be good enough (they would have to grow10-11% to hit revenue estimates). Chipotle is only projecting high single digit same store sales growth for 2012 in the first place, and even that is not likely. The bulk of the 11.1% increase in same store sales in 2012 was because of the price increases mentioned earlier. And on top of that, there is an odd accounting rule that makes Chipotle's restaurants wait 13 months after being operational before being included in same store sales.

This means that all the new restaurants built in 2011 (and late 2010) were not included in that number. As these new restaurants are included in same store sales you can expect numbers to decline. All the premium Chipotle locations were built a long time ago, new locations will be less profitable, especially in the current macro economic environment. A lot of Chipotle's new locations (called Model A locations) are being built in more suburban areas in strip malls, the traffic to these locations is heavily reliant on gas prices (which happen to be extremely high). Essentially, because of this 13 month accounting nuance, same store sales have been artificially immune to high oil prices, but starting in 2012, that trend will slowly reverse.

Rising Oil Prices

Brent prices have spiked since the beginning of Q4, when the average price per barrel was only around $105. Prices have averaged around $120 for Q1, an increase of approximately 14%. With much higher prices at the pump, and a real possibility of $5 gasoline by summer consumers are going to need to cut costs somewhere. Casual dining spots like Chipotle are the first types of businesses to see declining profits because of rising fuel costs. Consumers, and thus overall demand will be directly impacted because of higher costs to drive to restaurants.

Higher gas prices could also lead to higher food costs, which have previously been about 32% or expenses. We saw food costs rise about 32% in 2011, despite revenue only rising 23.7%. With even higher gas prices in 2012, and commodity (food) prices expected to continue to rise, Chipotle could run into serious trouble.

Hidden Margin Decay

Chipotle has done a fabulous job of hiding margin decay by raising prices throughout 2011, to cover rising food costs. After recently inflating prices up 20%, there just will not be demand for charging customers any higher prices in 2012. As Chipotle stops raising its prices and food costs continue to grow shrinking margins will become inevitable.

Margins already were on the decline in 2011 because of all the problems listed above, but that was with the price increases. In Q1 2012 Chipotle will have to deal with the burden of even higher gas, rising food costs, and slower growth without raising prices.

Massive insider selling

Chipotle has seen major insider selling throughout the past 6 months. Over 81,000 shares have been sold by Chipotle insiders since September, which translates into around $30 million. Insider selling is a typical leading indicator of when growth stocks are becoming overvalued. With continued insider selling, additional pressure will be put on shares if they continue to rise.

Institutional investors also sold about 2 million shares from Q3 to Q4, amounting to over $650 million. It is clear that those most familiar with the company are selling because they realize the risk/reward at these levels just isn't a favorable investment.


Chipotle is valued at absurdly high levels, even when modeling with growth estimates that are far too high (as shown above). Chipotle is currently trading at 26.5x 2015 EPS estimates of $15.39. That means even if exceptionally high expectations are met, in 4 years Chipotle will still be trading a P/E almost twice the average of the S&P. And that will be after 4 years of investing in a company that has returned 0% and has actually depreciated in value because of inflation.

Bottom Line

Expectations for Chipotle are about as high as they can get. Even if they are able to expand as planned in 2012, Chipotle will not be able to meet the high financial standards Wall Street has set for it. Declining margins caused by rising fuel prices and slowing same store sales will finally have an impact on Chipotle's bottom line starting in 2012.

Q1 2012 will be the first quarter where Chipotle will be able to deny slowing same store sales and decaying margins. For this reason it will be the catalyst bears have been looking for, to finally cause a major decline in stock price.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in CMG over the next 72 hours.