Chipotle Sell-Off: Reasons Not To Buy Yet - Part 2

| About: Chipotle Mexican (CMG)

Back in July, we published this piece right after Chipotle Mexican Grill (NYSE:CMG) got grilled after its 2012 Q2 results. Guess what, the same is happening after its 2012 Q3 results. Shares are currently down close to 15% at about $245. So, when a stock loses this much of its value due to one or two reports, people might be tempted to buy more. This article presents a few points why you should think again.

Still Overvalued: Let's get the obvious out of the way. In spite of the selloff, CMG is still trading at a price to earnings ratio of close to 30. That is for a company that is "optimistically" expected to grow at about 20% over the next 5 years. The expected growth rate is almost certain to be slashed over the next few days in the wake of the recent earnings report.

The industry PE is about half that of CMG's, while CMG's expected growth rate is slowly falling down to the industry's level. Agreed, this stock is seen as a "growth" story but a PEG of 1.5 still makes it look expensive. As investors have already started to realize, reversion to the mean is inevitable.

History: As mentioned in the previous article, once these high flyers start missing a couple of estimates, investors get skeptical real quick. The bad memories of a previous high flyer biting the dust come to mind immediately. Chipotle no doubt is here to stay as a business but the stock is still catching up to reality in spite of the recent haircuts. Analysts are perhaps starting to realize this and this morning, the ratings and price targets have been cut by quite a few of them.

  • Piper Jaffray slashed the target to $318 from $471 - a reduction of 32%
  • Wedbush slashed the target to $270 from $350 - a 22% cut
  • Jefferies cut it from $305 to $215 - a 30% slash

Pricing Power/Economy: Companies try to compensate for reduced demand by increasing prices but the way the macro economy is shaping up, it might not be a wise move to increase prices, especially given the reasons below.

Yum Yum: Talking about prices, Yum Brands (NYSE:YUM) comes into the picture. Chipotle recently got "Einhorned" with the hedge fund manager David Einhorn rightly pointing out that CMG is facing increased competition from YUM's cheaper Taco Bell menu. Proving that Einhorn is right, YUM reported solid earnings on October 9th, with earnings per share higher 25% YoY for the 3rd quarter. This in a way proves that the economy is indeed forcing people to settle for cheaper food, while compromising a bit on the quality.

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. Almost every stock in this industry has been having a hard time including McDonald's (NYSE:MCD) and Darden (NYSE:DRI). Only YUM seems to have bucked the trend with strong international sales.

However, from an investment perspective, McDonald's, Darden and YUM all pay you increasing dividends while waiting for things to turnaround. The same cannot be said of Chipotle obviously. With the market having a magical run in 2012, backed up by QE, maybe it's time to cut down the risks and focus on relatively safer stocks.

Disclosure: I am long MCD, DRI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.