Chipotle: Fundamentally Sound, But Overvalued Nonetheless

| About: Chipotle Mexican (CMG)

Scanning the line that stretches out the front door of the local Chipotle Mexican Grill (CMG), I start to wonder if this Mexican maverick is really worthy of all the hype. From praise for its operational efficiencies and healthy food options to fear around a category without many barriers to entry - lets talk about the absolute bonanza and the potential for a salsa-stained bubble burst.


With over 1,230 restaurants and sites set on international expansion - 2012 efforts have the stock pushing new 52-week highs with a cadence akin to celebrity couples filing for divorce. In fact, Chipotle has touched 37 new record highs so far this year, the most in the S&P 500. With a current stock price at $418, the future seems bright as it had its estimates and price target increased by UBS this week due to solid sales momentum. A neutral rating was issued with a $442 price target. Add that to a 470% plus gain for the past three years and this guacamole-infused champion of the fast casual restaurant world is on fire.

Much of the optimism built into Chipotle's stock could be based on the fact that the company is debt-free and paying for virtually everything with cash. Future growth options hide around every corner especially with the potential upsides to the burrito chain's Asian concept, ShopHouse. The Asian play is still testing the new concept, but early reports are that ShopHouse is a smashing success with no shortage of positive media exposure. If an internal focus is not enough to convert a non-believer into a burrito banner-waving disciple, feast your eyes on the Italian copycat that is Piada.

Piada is a brand spanking new Italian street food chain that has embraced the Chipotle model right down to the tiniest of details. While the fare is Italian based, the assembly line production and menu breakdown is eerily similar. Much like Chipotle, the incredible lunchtime lines at Piada can be up to 100 people deep around noon. Piada has quickly outgrown its test markets in Ohio and is scaling up quickly. While imitation is a sincere form of flattery for Chipotle, the proof is really in the fact that this concept of food prep, delivery and style can evolve to embrace Mexican, Asian, Italian and much more.

Average Americans and investors alike cherish the feeling that comes with ingesting and investing in healthy, locally grown, fast food options and this is really where Chipotle shines. Chipotle sources organic and local produce when practical and uses dairy from cows raised without the use of synthetic hormones. The company started using natural raised pork in 2000 and switched to zero trans fat frying oil in 2004. Not only is locally grown food cheaper and more reliable, it is also fresher, more flavorful, and free of undesirable products, like MSG and other preservatives.

In the age of the electric car and solar panels - awareness of environmental and ethical concerns puts traditional fast food restaurants like McDonald's (MCD) at a disadvantage. Meanwhile, Chipotle has been shouting its slogan from the rooftops, "Food with Integrity." With more and more focus on obesity and Diabetes, Chipotle is poised to carry the torch as a dining choice that actually offers some value on a nutritional and "go green" level.


While the buzz-worthy upstarts nip at Chipotle's heals, the old guard is sharpening its cheese graters as well. Yum! Brands (YUM) is currently gearing up for one of the biggest new product launches in Taco Bell's 50-year history. The new Doritos Locos Taco, which debuted earlier this month, features a shell made from Nacho Cheese Doritos Chips and many experts are forecasting a nice little bump for Taco Bell's 5,600-chain empire. This bump extends to Taco Bell's growing presence in China and India. If Taco Bell remains nimble and can get into emerging markets ahead of Chipotle, it could carve out a substantial portion of first-mover advantage thereby chipping away at Chipotle's international prospects.

Why are so many short sellers waiting in the wings? For starters, Chipotle's stock appears overvalued when you look at a simple price-to-earnings ratio. With a forward P/E ratio of 38.7, Chipotle is almost embarrassingly expensive when compared to market darlings like McDonald's with a P/E ratio of 15.4 and Panera Bread (PNRA) at 24.6.

With a market value of $13.10 billion, Chipotle has some explaining to do with the market valuing each individual restaurant at over $10 million. Look at the golden arches of McDonald's again and you'll see a fair market value of $3 million per restaurant and remember that McDonald's can serve and seat customers with a much quicker pace. Chipotle is certainly on a tear, but how do you justify some of these quick math valuations when growth in operating income/cash flow is below 20%?

Short sellers all agree that Chipotle is sharply overvalued at 60x earnings. It has had a few hiccups in 2012 with a dip here and a dip there as if testing the market and stretching its legs for a brisk run down the wrong side of the hill. There is no doubt that this stock is expensive and an overwhelming majority fear that a near term correction is coming.

Need more signs that Chipotle is headed lower? How about the fact that insider selling has been picking up steam over the last week. Chipotle CFO Jack Hartung has sold approximately 24,000 shares valued at $13 million since the beginning of March.

It's always hard to bet against a fundamentally sound company with customers willing to spend $10 to $15 on a burrito, chips and a drink, but can this magic last forever? Many analysts emphatically agree that Chipotle is going down and a 2-3% pullback is inline over the next few weeks regardless of other global market conditions.

With a Chipotle correction in the cards, what's a restaurant hungry trader to do? Any sort of horrific backslide seems unlikely, but a smart play could be to jump in for a little ride only after a 5% dip rears its ugly or beautiful head - depending on the side of the fence you are playing on. With plans to open 155-165 new stores in 2012, why not play the dips and ask for double meat on your burrito bowl the next time you pass by the Panera entrance on your way to the posh pepper player that is Chipotle.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.