Chipotle Still Overpriced After Earnings

| About: Chipotle Mexican (CMG)

On April 19, Chipotle Mexican Grill (NYSE:CMG) reported Q1 earnings with a top and bottom line beat. The company reported $1.97 in EPS (better than analyst estimates at $1.93) and $640.6 million in sales (better than analyst estimates at $630.6 million). Without doubt, these were very strong figures for Chipotle. However, the company's current share price only makes sense on the assumption that Chipotle will continue to grow earnings at 30% or more annually for many years to come.

However, this is not likely to occur. The analyst community currently expects earnings growth of around 30% for this year and 25% for next year, with somewhat slower growth thereafter. But these estimates may be too optimistic, because Chipotle will face an increasing level of headwinds in future quarters and years. Sales and earnings growth are likely to slow down beginning next quarter and continuing on through the summer.

The primary headwind facing Chipotle is that the company will soon lap menu price increases made in 2011, and will thus lose the benefit of those price increases as a driver of same-store sales growth. Chipotle management stated on the call that menu price increases caused 4.9% of the overall 12.7% comp increase. While management believes that it still has additional pricing power, the company has decided (wisely, in my opinion) to forgo further price increases for now, in order to focus on long-term customer growth and loyalty.

Chipotle's strong Q1 results were also helped by the leap day, which added roughly 1% to comps, and by mild weather. Thus far, Q2 weather patterns have been much closer to last year. For instance, in the Chicago area (home to me and about 6% of Chipotle's stores), April weather was generally worse than March. This tends to depress restaurant sales. Lastly, with recent sales growth, many Chipotle stores are nearing a peak in rush-hour business, as they simply cannot handle additional customers. Management is trying to improve efficiency with initiatives to increase throughput, but there is obviously a limit to how fast customers can be served. With Q2 and Q3 being much stronger seasonally than Q1, throughput will be a bigger constraint on sales in coming quarters.

The result of all this is that Chipotle's management is guiding for mid-single digits comp store sales increases for the full year. While this is likely a conservative figure, analysts are currently estimating over 22% annual sales growth for 2012, which implies perhaps 9%-10% comp sales growth. This seems like a stretch. Because Chipotle trades at a high valuation of nearly 50X expected 2012 earnings, even a small slowdown in the growth trajectory could lead to a large drop in the stock price due to multiple contraction. This is just what this Seeking Alpha author predicted last week; there are some technical indicators that Chipotle may be on the verge of multiple contraction.

Chipotle is certainly not quite as mature as competitors like McDonald's (NYSE:MCD) and Yum Brands (NYSE:YUM). Those stocks each trade at around 20X multiples. Chipotle certainly deserves a higher multiple, given that it has room to grow domestically and has essentially no international presence to date. However, McDonald's and Yum Brands both have larger total market opportunities than Chipotle, which is too pricey for many working class and middle class individuals. As a result, it seems that Chipotle is being given too high a premium relative to its more mature competitors. To provide one last data point, Panera Bread (NASDAQ:PNRA) (which competes in a similar fast casual segment) is valued at less than 30X 2012 estimates. Panera provides a lot of the same upside as Chipotle, as an established but growing concept, at a more attractive valuation.

Chipotle is certainly a compelling story. However, at its Wednesday close price of $423.02, it is difficult to see any real upside. On the other hand, if investors become spooked by the potential slowdown in sales growth discussed above, the stock multiple could contract to a more Panera-like 30X-40X multiple, creating 15%-30% downside.

Disclosure: I am short CMG.

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