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Mendez
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Graduated from Finance in University of Puerto Rico. CFA Charter Level 3 Candidate.
  • Chipotle's Over $400 - A Free Cash Flow Analysis 2 comments
    Apr 24, 2012 11:27 AM | about stocks: CMG

    Chipotle's over $400!(NYSE:CMG) That was my first thought yesterday when I was looking for stocks that have doubled in the last two years. Chipotle has grown from low 120's back in mid 2010, to a high of 443 in April 13, 2012.

    Considering the fact that CMG is a burrito fast food chain, its growth is very surprising. With a P/E ratio of over 50 it is one of the highest, if not the highest in its peer class.

    Company

    P/E

    Chipotle (CMG)

    57.2

    Domino's Pizza (NYSE:DPZ)

    20.3

    Panera (NASDAQ:PNRA)

    16.3

    Brinker Intl (NYSE:EAT)

    17.4

    Cheesecake Factory (NASDAQ:CAKE)

    18.3

    Using only P/E ratio we can think that the stock is overvalued, but I prefer to use one more valuation technique before arriving to that conclusion.

    I decided to do a Free Cash Flow analysis on CMGto see if it's Free Cash Flow confirms its stock price. It's a very simple analysis that is often used to see if a stock is correctly valued or not.

    Step 1: Compute growth rate (g)

    For this we are going to use a two-stage growth. A 5 year short term growth rate and then we assume the company will decline to a long term 5% growth rate.

    Because CMG doesn't have a dividend, I'm going to use it's average ROE as a proxy for the next 5 years growth.

     

    2009

    2010

    2011

    ROE

    18.03%

    22.07%

    20.58%

    Average = 20%

    Step 2: Computer Required Rate of Return (r)

    For this I'll use the popular Capital Asset Pricing Model (CAPM).

    R = Risk free rate + Beta*Market Risk Premium.

    Risk free rate = 3.5% (a bit higher than the 10 year Treasury Notes rate)
    Beta = 1.02
    Market Risk Premium = 6.2% (obtained from Professor Damodaran's website http://pages.stern.nyu.edu/~adamodar/ )

    R = .035 + 1.02*.062 = 9.82%

    Step 3: Calculate Free Cash Flows

    We'll be calculating now the Free Cash Flow to the Firm for the year 2011. After that we multiply it by the growth rates to get the next 5 years cash flows and the terminal value.

    CFO

    $411,096

    - Fixed Capital Investment

    151,147

    + Interest after tax

    2,120

    FCFF

    $ 262,070

    Cash Flows

     

    2012

    2013

    2014

    2015

    2016

    2017

    FCFF

    314,483

    377,380

    452,856

    543,427

    652,113

    684,718

    PV of FCFF

    286,352

    312,885

    341,876

    373,553

    408,165

    14,193,992*

    * This value is called the terminal value, the value assuming the company will grow at the same rate forever. It is calculated as : 684,718 / r - g, were r = 9.82% and g = 5%.

    Step 4: Value of equity

    When we add all the Present Value of FCFF we get the value of the firm = $15,916,823.
    We subtract the 2011 liabilities to get the value of the equity.

    Value of firm: $15,916,823
    - liabilities: 1,044,226
    = Value of equity: 14,872,597

    Step 5: Value of shares

    Chipotle has around 31.7 millions shares outstanding. We divide the value of equity by the number of shares and we get the value of each share.

    = $14,872,597 / 31,700,000 = $ 469.17 x share

    Conclusion:

    The free cash flow valuation is a great tool to valuate companies. Cash flow is harder to manipulate than earnings, for this reason I prefer to use this analysis instead of other comparative techniques that use earnings and other values.

    From the analysis we can conclude that Chipotle is actually undervalued! Using CMG's current price of 410 (as of 4/24), the stock is 14.4% undervalued.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Themes: Free Cash Flow, valuation, Chipotle Stocks: CMG
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Comments (2)
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  • bakerjoa
    , contributor
    Comment (1) | Send Message
     
    what is the formula for how you calculated the PV of FCFF?
    8 May 2012, 04:25 PM Reply Like
  • Mendez
    , contributor
    Comments (16) | Send Message
     
    Author’s reply » Thanks for your question bakerjoa.

     

    I used FCFF / 1 + r ^ n

     

    Example: PV of FCFF in 2012 = 314,483 / 1.0982 = 286,352 (not exact due to rounding)

     

    The correct way would be to use WACC instead of r, but Chipotle's WACC apparently is around 6-7% (http://bit.ly/K0FTdK), so I decied to use a higher rate, in these case, required return.
    9 May 2012, 09:57 PM Reply Like
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