I am not one to argue with Chipotle (CMG) stock having decreased dramatically since the company reported earnings this week. It was warranted to decline even when taking into account the stellar growth the company has achieved. The stock was undoubtedly over-priced and at a P/E ratio that made it susceptible to anything but a large earnings surprise. As evidence of an overvaluation, the price of CMG stock pre-earnings was valuing average revenue per store at $10.5 million - a substantial and unheard of premium for a company that averages a fifth of that amount. Regardless, as irrationally overpriced that it was in the first place, I must argue for some rationality in how far the stock has fallen since Tuesday.
Let's put the report into context to shine some light on what occurred throughout the quarter. The company missed revenue by approximately 12 burritos per store per day. CMG reported top line growth slightly below expectations and was shy of analyst forecasts by approximately $14 million. In its most recent annual report, Chipotle had 1262 stores open at the end of 2011 and guided that it would open 60 more by years end. When you spread the revenue miss among each store over the quarter, it equates to a shortage of approximately $120 per day at each store and we can just assume that a customers average spend is $10 per visit.
When put in this context, I believe that the selloff is unwarranted and the stock should still command an irrationally high multiple. The fact is that Chipotle has weathered commodity cost increases very well and will likely continue to do so in light of more projections that feed costs will drive meat prices north again. This is a valid point, yet I would revert your attention back to the same arguments in 2008, 2009, 2010, and 2011 that predicted the downfall of CMG stock. Commodity cost issues do have the potential to drag on the company, yet the benefits in top line and bottom line growth far outweigh the losses from a 100 basis point decline in margins. Worth noting as well is that Chipotle reported its best net profit margin in the past five quarters around 11% this week.
So, the potential risks are certainly present in a high P/E multiple, susceptibility to "disappointing" earnings, and commodity pressures. I believe the latter risks muddy the investing outlook for CMG and don't focus on the core of what is going on. The truth is that even if multiples compress and commodity prices eat away a portion of margins, the stock will still be profitable in the long-term, which is my investing horizon. Just review the true prospects for the Chipotle and you'll see that the company is opening 60 stores per year and growing same store sales above the industry average at 8%. The most supportive investing evidence can be found similarly by just sitting outside a Chipotle at various times of the day. It is likely that the store is bustling with a line reaching near to or out the door. I've traveled across the country and experienced this on nearly every occasion. That to me, while simple, like measuring revenue misses in burritos per day, is the best evidence of what the true picture is for Chipotle.
I do admit, the investing environment for short-term traders is less favorable, yet my perspective takes into account more than just a quarterly report. For me, I view it as bottom line numbers will be far higher than they are today, and a P/E compression to values in line with McDonald's (MCD) and Yum Brands (YUM) is foreseeable in between now and a few years down the road. Even in this environment, the outlook if positive.
Disclosure: I am long CMG.