Burrito chain Chipotle (CMG) reported solid, but slowing, third quarter results Thursday afternoon. Revenue increased 18.5% year-over-year to $700.5 million, while earnings grew 19.5% year-over-year to $2.27, both slightly below consensus expectations. As we had outlined previously about why a DCF process could have saved you big bucks in Netflix (NFLX) in this article here (long before its massive sell-off), it may also be worth reading this article here when we warned investors of Chipotle's massive impending sell-off (long before it happened). We called Chipotle "one of the most overvalued firms on the market" in April 2012.
Though both Chipotle's revenue and earnings growth rates are still impressive, the sequential slowdown in same-store sales indicates that the excitement surrounding new food offerings (Doritos tacos, its Cantina Bell menu) at Taco Bell (YUM) are stealing the moment. Same-store sales grew 4.8% during the quarter, compared to 8% during the second quarter, and 12% during the first quarter. The firm doesn't see things getting much better, forecasting mid-single-digit same-store sales growth during the fourth quarter, and flat-to-low single digits expansion during 2013. Management also tempered expectations for the fourth quarter, mentioning tougher price comps, as well as the unseasonably warm winter during the fourth quarter last year.
Strong avocado crops have offset other input inflation, and the company sees only modest food cost inflation during 2013. The firm does not intend to raise prices unless inflation is higher than expected. Overall, food costs were down 50 basis points year-over-year to 32.6%, though costs are 2.5% higher on an absolute basis. Operating margins were also strong, expanding 210 basis points year-over-year to 28%. Though likely unsustainable, the fantastic operating margins reflect Chipotle's strong pricing and superb operations.
On the positive side, the company projects it will open 165-180 new stores, with 70% in established markets and 30% of locations residing in new markets. Though there's always a chance for cannibalization, we think convenience tends to win dollars, especially in a high gas-price environment. Chipotle has become a huge national phenomenon, and we suspect underserved markets will relish the popular chain.
Overall, we thought the firm's guidance was negative, but not alarming for the company's long-term growth story. Every company hits a critical mass where momentum begins to retreat, and sales growth starts to stall-exactly what we believe has happened to the burrito maker. The company's focus on keeping costs reasonable and creating excellent products has not wavered, so we certainly don't think Chipotle is heading towards extinction anytime soon.
However, the story with regards to the firm's share performance has been valuation-momentum investors simply continued to bid up the name to sky-high and unrealistic levels. We've thought the name was overvalued for the past year, but decelerating results finally provided a downside catalyst. To view a President of Equity Research, Brian Nelson's video on why DCF valuation is important, please click here. We think shares are fairly valued at this time, and while some downside may remain, we don't think it warrants a put option position in our Best Ideas Newsletter at this time.