Chipotle Burns Investors Again But Valuation Looks Better Now

| About: Chipotle Mexican (CMG)
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Chipotle (NYSE:CMG) used to be a high flyer. For a while, it looked like the company was climbing the stairway to heaven. The company's share price went up, up and up. Even though fundamentals didn't support such an upwards movement, Chipotle was the flavor of the day and it had no place to go but up. Despite warnings from many people (for example myself) the stock became a bubble and it has been bursting badly for the last couple quarters. On Thursday, the company's earnings report didn't help the situation either. As of the after-hours of Thursday, the company's share price is $251, which is down significantly from the share price of $440 which was achieved by the company back in April.

Chipotle earned $2.27 in the last quarter, which is slightly below the $2.30 expected by analysts covering the company. The company's quarterly revenue was $700 million, which is right below the $702 million estimated by analysts. Overall, the company's quarterly results weren't bad. The company's revenue is up by nearly 20% and the company's margins are on their way to improving. Then what seems to be the problem for investors of the company?

It looks like the culprit is same-store sales. After increasing in double-digit percentages for a few years, the same-store sales are increasing at a single percentage rate. In addition, the company is committed to opening between 100 and 200 new restaurants annually, but this will not be enough to make investors happy. The investors of Chipotle want to see double-digit growth in same store sales, which is very difficult to achieve in relatively saturated markets.

The slowing economy and increasing material costs pressure the company's earnings significantly as it doesn't want to raise its prices high enough to scare customers off. On the other hand, the company can go for only so long without passing the increased costs on to customers. In the earnings call, the company's management said that they expect 3-6% higher food costs in 2013 but at the same time, they said that they did not plan on any specific price increases at the moment. The company pretty much said that it didn't want to be the first company to fire the gun and that it would wait and see until a competitor raises their prices

The company will be opening between 160 and 180 restaurants in the next year and it is reportedly well on its way to either reach or pass the guidance it provided in the beginning of the year. Chipotle has already opened 123 restaurants in the first 3 quarters of this year, including 36 in the last quarter.

Most analysts rate Chipotle as a "hold" with a price target of $350. Now that the share price fell as low as $250, many analysts will probably lower their target price. On average, analysts expect the company to end this year with a profit of $9.02 per share, followed by $10.90 in 2013 and $13.30 in 2014. The company's current share price of $250 signals a forward P/E ratio of 23 for 2013 and 18 for 2014. Quite frankly, this is the lowest forward P/E ratio enjoyed by Chipotle in years. In one of my articles, I said that the company would become attractive if its P/E ratio fell below 30 and this may be happening for the first time in a while. Chipotle is not a value play, so I don't expect it to have a P/E ratio of 10-15 anytime soon. Chipotle is a growth company and it can easily support a P/E ratio around 25.

When we look at Chipotle's balance sheet, we see $421 million in cash and total assets worth $656 million. The company is pretty much debt free. If we add this to the equation, it becomes evident that the company can support a P/E ratio a little higher than the ideal number of 10-15.

At the moment, I would wait a few days before touching this company. I would wait for the dust to settle. The company's plunge might take more than one day as it is mostly owned by institutions and the institutions tend to dump their shares in the market over a period of days. Once most shorts are in and many institutions are out, I would initiate a position in this company. Even though I kept saying that Chipotle was overvalued for many months, I don't think Chipotle is a bad company. The company is still a solid growth story.

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

Additional disclosure: I may initiate a long position within the next 2 weeks.