Chipotle Sell-Off: Reasons Not To Buy Yet

Jul.20.12 | About: Chipotle Mexican (CMG)

Chipotle Mexican Grill (CMG) got grilled after posting its 2012 Q2 results. Sales at existing restaurants (open at least 13 months) grew only by 8%, while analysts expected 10%. The CEO, not surprisingly, put it down to the tough economic situation - people having lesser spending power. The stock right now trades at $326 pre market, a loss of about 20%. So, when a stock loses one fifth of its value due to one report, people might be tempted to buy more. This article presents a view points why you should think again.

Still Overvalued: Let's get the obvious out of the way. In spite of the sell off, CMG is still trading at a price to earnings ratio of close to 40. That is for a company that is "optimistically" expected to grow at about 20% over the next 5 years. The industry PE is about half that of CMG's. Agreed, this stock is seen as a "growth" story but a PEG of 2 plus makes it look even more expensive. Valuations might not seem to matter now but eventually reversion to the mean is unavoidable.

History: CMG is seen as a growth/momentum stock. When these stocks go up, they are express trains. When they start falling and lose investor confidence, expect a nasty retaliation. When Netflix (NFLX) lost ground initially, lots of people picked it up due to the "fall" but it dropped all the way from $300s to $60s. Agreed, CMG's story might not be so ugly as NFLX's, but the point is, these stocks go up or down depending on the current sentiment and have very little to do with valuation whatsoever in the short term.

Pricing Power: CMG executives supposedly believe they can compensate for weaker sales with increased prices. Well, the reduced sales has to do with people feeling the pinch in their pockets, right? Increasing prices would work for "staples" but could backfire for the others during tough times.

Yum Yum: We wrote in an earlier article that Yum! Brands (YUM) was rumored to open a store rivaling CMG. Well, its no longer a rumor as Cantina Bell is now official. Cantina Bell's menu closely resembles that of CMG and is more upscale compared to the usual Yum chain of stores but the prices are lower than that of CMG's for obvious reasons. Kentucky and California residents - please try out Cantina and provide your feedback!

Competitors: The previous point was about the competitors from the business standpoint. This is about the availability of better stock alternatives in the restaurant industry. With everyone and their grandma predicting a tougher time for the economy in general, why would you want to risk your money with CMG when you have companies like McDonald's (MCD), Darden (DRI) and the power of their dividends.

Disclosure: I am long MCD, DRI.