In this article, I take a look at Chipotle Mexican Grill, Inc. (CMG), a restaurant that may offer investors upside potential that outweighs the risks. We'll use management effectiveness ratios, book value-share, price-sales, and price-book value, among others, to evaluate Chipotle.
Additionally, macro-economic indicators are provided at the end of the article. As part of investment analysis, analysts should consider both the company fundamentals and the macro-economic landscape. The macro-economic picture in the U.S. is deteriorating. In Europe, the economy is contracting.
European officials are working towards recapitalizing the banks in Spain. Also, European officials are investigating pro-economic growth policies that would reduce the sovereign risks the region is facing. Until pro-growth policies are implemented, and Spain's banks are recapitalized, sovereign risks remain.
Further, there is a chance that housing prices in the United Kingdom and France will decline. Unlike U.S. housing prices, home prices in the UK and France did not decline substantially during the Great Recession. Income may not have grown enough to sustain the current level of housing prices. Therefore, it is possible that the global financial system could face risks stemming from a decline in home values in two of the world's largest economies.
Rating System
Buy - Be long
Neutral - No position
Sell - Be short
(The ratings, research and analysis in this article should be considered as starting point for further research.)
Chipotle: Sell
Investment Thesis
Investors should distribute shares of Chipotle on valuation as economic headwinds should cause the share price to decline. If the U.S. enters recession the premium investors pay for shares of Chipotle should decline. Further, the company may open few stores during a recession and revenue growth could slow. Investors should position themselves net short.
Enterprise Operations
However, book value-share and revenue-share increased over the last few quarters and management is effective based on the management effectiveness ratios.
According to the company's financial statements, current assets increased in the first quarter of this year compared to the fourth quarter of 2011. Additionally, current assets are greater than current liabilities; the firm is liquid. The financial leverage ratio is just over one.
The cash balance decreased 7.7 percent in the first quarter of 2012 compared to the fourth quarter of 2011. Although, the investments account almost doubled. Current liabilities decreased 20 percent in the first quarter of 2012 compared to the fourth quarter of 2011.
Total revenue in the first quarter, compared to the year-ago quarter, increased substantially as net income increased 35 percent. In the first quarter of 2012, earnings weren't high quality. Additionally, cash from operations wasn't enough to cover cash used in investing; the company is generating cash from financing.
Chipotle may have some issues with the food that it serves. The company typically serves high quality food and supply constraints may limit the ability of that to continue. Further, as the company grows it will become increasingly more difficult to serve customers the same quality of food that is served, while the enterprise is relatively small.
The total number of restaurants increased 15 percent in the first quarter of 2012 compared to the year-ago quarter. If Chipotle continues to open restaurants at a double-digit growth pace, the valuation may continue to represent the premium investors pay for growth. The enterprise is paying a 39 percent effective tax rate. Management needs to do a better job of managing the tax bill.
Legal Risks
There isn't any long-term material risk from legal cases that the company is disclosing.
Economic Risks
The macro-economic risks from potential fiscal consolidation in the U.S. and European Union could cause valuations to decline farther. Additionally, Chipotle's valuations could decline if revenue and earnings growth slows. Some investors may want to protect long positions by buying put or selling call options.
Company v. Industry (TTM)
- Return on Assets: 17.22 v. 9.60
- Return on Investment: 18.79 v. 13.59
- Return on Equity: 22.75 v. 18.13
(The management effectiveness ratios are courtesy of Reuters.)
Price Forecast
| Baseline | Alternative Baseline | Adverse | |
| 2012 | $325 | $300 | $420 |
| 2013 | $250 | $225 | $360 |
| 2014 | $280 | $255 | $300 |
In the baseline scenario, the holding period's rate of return is roughly 34.7 percent over the next year-and-a-half. In the alternative baseline scenario, the hold period's rate of return is roughly 41 percent over the next year-and-a-half. The adverse scenario suggests a holding period's rate of return of roughly 22 percent, but occurs in 2014. The current priced used for estimates is $383.
Valuation
Click to enlarge
Book value-share is increasing; the increase in book value-share is bullish.
The share price is rising and is currently coming off of a recent high.
Price-sales is rising and is currently coming off of a recent high.
Price-book value is rising and is currently coming off of a recent high. Typically, a high price-book value ratio suggests investors like the growth prospects of the firm.
Macro Environment
U.S. GDP Forecast
| Baseline | Alternative Baseline | Adverse | |
| 2012 | +2.3 | +1.8 | +1.8 |
| 2013 | -0.5 | -1.5 | +1.5 |
| 2014 | +2.4 | +1.6 | -0.5 |
In the baseline scenario, I see economic growth continuing through 2012 with a recession in 2013 and economic growth resuming in 2014. Under the alternative baseline scenario, economic growth this year is slower than the baseline scenario and the recession in 2013 is deeper. In the adverse scenario, the recession occurs in 2014. Under the baseline and alternative baseline scenarios, US equities are in a bear market during 2012 and/or 2013.
ISM non-manufacturing PMI is declining; the index is expected to continue to decline in the coming months.
Non-farm employment change is declining; the pace of job growth is expected to continue to slow.
CB consumer confidence is starting to decline; the index is expected to decline in the coming months.
Disclaimer: This article is not meant to establish or continue an investment advisory relationship. Before investing, readers should consult their financial advisor. Christopher Grosvenor does not know your financial situation and ability to bare risk and thus his opinions may not be suitable for all investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
