As of closing on August 10th 2012, Chipotle's (CMG) share price was $295 which is 34% lower than the 52-week high price of $442 reached just a few months ago. For months, many analysts warned that Chipotle was overpriced and it was due for a sharp correction. Even I had a couple of articles about Chipotle stating that it was one of the most overpriced companies in the market. Of course, there were also many analysts that were overly optimistic regarding the stock, setting up price targets as high as $500 for the company. Even the company itself issued warnings regarding the slowing same-store growth and contracting margins in the last couple quarters, but that wasn't good enough for many of the overly optimistic investors and analysts of the company. Now that the correction has happened, is Chipotle a good buy?
First, I will look at it from a psychological perspective. For the last several years, Chipotle was the "sweetheart" of Wall Street. When a company becomes a Wall Street Sweetheart, it can rally for a long time with or without a legit reason. But again, many times Wall Street dumps its sweethearts and these stocks take a long time to recover. For example, during the dot.com bubble, Cisco (CSCO) was one of Wall Street's sweethearts, and for the last decade, the company's stock price appreciation failed to impress many investors as it fell way below the company's earnings growth. Now, we don't know if Chipotle will be "dumped" from the Wall Street Sweetheart status or not. Psychologically speaking, if it continues to receive support from the analysts and large investors, the stock price can recover quickly regardless of the company's fundamentals. Otherwise, it may be a tough road for the company even if it develops the strongest fundamentals ever. This is just the psychological aspects of the matter.
As much as the numbers go, the company's P/E ratio dropped from 57 to 36 in the last few months. This is encouraging for the investors wanting to get in. As Chipotle continues to enjoy double-digit growth and has very low amount of debt in its balance sheet, the company could support a P/E ratio of 30. While the current P/E ratio for Chipotle is still a bit high, the psychological factors I mentioned above will be the real determinants of the bottom price for the company.
Because Chipotle already got many of the premier locations in American cities, most of the company's future growth will rely on either international markets or offering different niches, such as a Chinese restaurant. Currently, the company has very little exposure to international markets with a few restaurants here and there. Outside of the USA, the company is not well known and it is difficult to know what kind of reaction and demand it can get in places like Europe, Asia and Latin America. The company will have to do its homework and determine which countries would be more receptive to its products, or perhaps offer completely new products in countries that may not be as receptive to its current line of products.
The company's same-store sales growth rate is 8%, which is much higher than the industry average of 3%. Yet, this is not able to satisfy the investors of the company as it enjoys a higher P/E ratio than the industry average. The company sees growth through both new stores and existing stores.
Of the 22 analysts covering the stock, 14 recently increased their earnings estimate for this year for the company. The analysts currently expect the company to earn between $8.61 and $9.30 per share. The average earnings estimate for the company is $9.02 per share, giving it a forward P/E ratio of 32. In 2013, the analysts are expecting the company to make $10.94 per share followed by $13.42 in 2013 and $16.75 in 2014. This would yield a forward P/E ratio of 17 for 2014. Of course, if the company expands overseas successfully, the earnings might be much higher than the analyst estimates. According to Yahoo Finance, Chipotle has $405 million of cash, $124 million of short term investments and $169 million of long term investments, giving it cash and equivalents of $698 million. Given the company's market cap of $9.36 billion, its cash holdings make up 7.46% of the company's market value.
Back in April, when Chipotle's market value was divided by its number of restaurants, each restaurant was valued at $11 million. Obviously this was a very high valuation for a burrito restaurant with a simple business model. Today -according to the latest earnings call- Chipotle has 1,316 active restaurants. According to the company's market value, each Chipotle restaurant has an average value of $7.11 million. This is not a very attractive valuation either but much better than it used to be.
I rate Chipotle as hold as I am still not totally convinced of Chipotle's valuation. If the company's share price falls further and carries its P/E ratio at or below 30, I might consider initiating a position in this company. Until then, I will be on the sidelines.