Chipotle Mexican Grill (CMG) traded down 15% on Friday, October 20, 2012 after the company reported Q3-2012 earnings of $2.27 versus consensus of $2.29. To be fair, the miss was really due to the $1 million bad debt expense related to contractor insolvencies. Without this special expense, earnings were actually in-line with consensus. The stock is now trading around $243 versus its 52-week low of $239.54, down 28% in the past 1-year. The stock trades at a P/E multiple of 27 times, and a forward multiple of 22 times. This is a premium to the industry average of 19 times. The company's peer McDonald's (MCD) trades with a P/E multiple of 17 times, and a forward multiple of 15 times. More importantly, Chipotle does not pay you to take risk, while McDonald's pays you 3.5% to wait for a better future. The 5-year dividend growth on McDonald's is 23%.
I like to first look at the credit story, before I look at valuation, and equity fundamentals. As of September 30th, 2012, the company has cash & cash equivalents of $421 million, $0 public debt, and positive free cash flow since 2009. Clearly, the liquidity is not at risk, and for retailers this provides good downside protection for the stock. Also, Chipotle management announced an additional $100 million share repurchase program. This will also provide a floor for the stock. That being said, is the underperformance of the stock an opportunity to invest in Chipotle? A quick look at the risks related to the fundamental story:
Management guided 2013 comps to be flat to up single-digits. The company does not have any defined plans to accelerate comps. A creative, and a well-priced menu are primary in the competitive Quick Service Restaurants (QSR's) landscape. Management mentioned that they are open to menu price increases in 2013, but details were not provided by management. There is also the question of how customers will react to menu price increases given that this is a very competitive business. A natural alternative for some customers could be Yum! Brands (YUM) Taco Bell.
Food inflation in the mid single-digit range in 2013 will also impact restaurant margins. This in comparison to the 2.5% inflation in 2012. Management did not provide details on the negative impact on margins. Management needs to quantify the impact on margins to make us feel comfortable about the bottom line. The only color we got from management was that favorable pricing on avocados will offset the higher prices of protein and dairy products.
Also, management is open to trying drive-thru locations. Although this could be a benefit in the suburban locations, management did not give any details on the timing, and the extent to which it would be pursued.
I will conclude by saying that I'd rather wait to see management progress on its plans before taking the plunge. It's a tough macro environment, and a strong competitive space for QSR's. Management talked about possible menu price increases, and the establishment of drive-thru locations without giving any details. Although these are long-term positives for the company, they do not impact valuation in the short-run. These initiatives could possibly take more than one year to implement. This stock becomes interesting to me when I get more details on the timing of the initiatives, and management can quantify the impact on earnings.