By Parke Shall
We think the notion that Chipotle (NYSE:CMG) is trading at $450 per-share after the report they posted last night is crazy. To put it lightly, we think the company's results were far worse than what the street expected and the company's lack of visibility into the future puts them at a precarious situation where bulls must defend the company's aggressive growth multiple while the company is not growing and while the market overall is in a sticky situation.
CMG reported last night. The company reported better than expected EPS for the quarter, but the outlook was grim. The company said that they expect to have a very rough 2016 and that they were projecting break even profitability for the first quarter. Here are some more of the details,
- Chipotle Mexican Grill is off 1.6% after hours after reporting revenues that dropped 6.8% and missed expectations amid a CDC investigation of E. coli bacteria incidents at its restaurants.
- It said same-store sales tumbled 14.6% Y/Y, and restaurant level operating margin slid 700 basis points to 19.6%.
- Store count rose by 79 in Q4, to bring the total to 2,010. Food cost ratio was down 120 bps to 33.8% of revenue, with continuing relief in dairy and avocado prices, and a decline in beef prices.
- For 2016, it sees 220 to 235 new openings and a full-year effective tax rate of about 39%.
- Chipotle also reported its first quarterly revenue decline (-6.8% to $997.5M) in its history as a public company
The company stated they have little outlook into 2016 and expect breakeven results in Q1.
As we said in our last article, we did not think the CDC all clear was a great reason to go out and buy the stock. We made note that there was a huge difference between the CDC clearing the company and the company's customer base returning to make purchases. Until the latter of these two happened, we made the case that CMG may not see any real fundamental traction with their business. Yesterday's earnings call seems to reiterate this notion. While the E. coli scandal is now behind the company, it doesn't look as though customers are flocking back to stores to eat.
Another interesting piece of information that was revealed yesterday is the fact that the company had received additional subpoenas broadening the scope of the already in place criminal investigation related to the way that the company handles food products. The fact that the government is broadening this investigation and is now looking back to January 2013 should give investors pause about a whole new possible set of bad headlines for the company. In the rare case where the company is found to be criminally negligent, it is going to make the E. coli scandal look like small potatoes.
We saw what a negative news cycle can do to the company already, we think the repercussions would be significantly worse if the company had to face yet another negative news cycle.
As we stated in our latest article, the company also said that they had not found out the source of the E. coli. While it is great that the company has put new quality control measures in place, it seems to be somewhat of an empty victory, claiming the E. coli has been eradicated but not really being able to point out the source where it originated. As an investor and a consumer, that would make us nervous.
The problem with CMG's valuation is that it's multiple is making an assumption that the business is going to run very smoothly for years and years to come. This is just not the case.
We think it is very irresponsible for Wall Street analysts to place a multiple on this company between 30X and 40X, as those types of multiples are reserved for companies who have extremely little margin for error. The growth needs to be sustained very clearly and it must be blue skies ahead for a company to deserve such a multiple. The case of CMG is just the opposite. How can an analyst come out and slap in multiple on 2017 or 2018 earnings to arrive at a price target over $500 when the company itself has said they have no visibility into the way the business is going to operate over the next year?
We still do not know whether or not the backlash from this incident is going to be short-lived, as some analysts are predicting, or more disastrous. CMG would not be the first company that would have been taken out by health violations and allegations of E. coli, it happens to restaurants all the time.
The difference is that these restaurants aren't publicly traded entities. We think the most optimistic of valuations should be focused on an extremely conservative EPS number of $10 for next year and that the multiple needs to come down significantly because analysts can no longer responsibly fathom the concept of this company growing uninterrupted and doing business uninterrupted for the next 15 to 20 years, let alone the next 5 years. This all needs to be handicapped in the multiple, which needs to come down.
We are also unsure about the company's plans to allocate it's capital in the coming year.
We are not sure that opening stores more aggressively in this environment, coupled with spending hundreds of millions of dollars on a share buyback are the right ways to manage the company's capital in what is still a crisis time. For the company. This does not make us feel confident for the future, as we would prefer the company to save its capital and build a war chest in case it has more legal or public relations battles that it has to fight.
After looking at the poor same-store sales numbers and poor comparables for this last quarter, combined with a broadening criminal investigation, combined with the company's uncertain outlook for 2016, we think a 30X multiple on $10 EPS next year should be a very conservative way to value the business if you are on the bear side. We think things could actually be significantly worse, pending how the company does in 2016, but we think fair market value for CMG here should be much closer to $300.
Disclosure: I am/we are short CMG.
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.