Decreasing Chipotle Traffic Could Spell Trouble

Includes: CMG, MCD
by: The Market Hick

I am a hard core Chipotle (NYSE:CMG) fan, let's get that straight right off the bat. I was eating at its first store on Evans Ave. here in Denver within their first year of opening (my girlfriend-now wife turned me on to the place). In fact I blame them for adding about 2 inches to my waistline! I took a lot of my friends there, they liked it and likewise have been hooked on those fabulous burritos.

I watched the chain grow by leaps and bounds and followed closely as it partnered with McDonalds (NYSE:MCD) and later went public. I bought within in the first week of trading and subsequently added to my position in the next few weeks. I rode that stock to an incredible profit. However when I saw food costs rising and the subsequent price increases at their restaurants, I got out. Chipotle used to offer a great value with those $5 burritos, but when the prices started to head above $6 I sensed it'd lose a bit of momentum.

Now we see a stock that hit a high of over $150 trading at $51. Value investors might be tempted to get in at these levels, after all we have a good restaurant stock that practically defined the fast casual concept now trading at 21X earnings and 17X next year's with a PEG ratio of .88. If those are the metrics you use to judge a growth stock, fine. Those metrics have worked well in the past and might in the future, but I'm leery of buying any stock in today's environment based on future growth prospects. Further I believe that meaningful earnings growth will be hard to come by for the foreseeable future.

All those friends I have turned on to Chipotle serve as a great barometer of the company's business. We have noticed a marked slowdown of traffic when we go there, and it's not just here in Denver but across the Midwest and out to California (I have over 20 people who I survey). And it's the traffic that counts with any growing restaurant company. Granted we're not surveying every store and the survey is rather unscientific, but I'm a seat of the pants kind of guy and I trust my gut and what my friends are telling me. Quite a few of us bought into Chipotle when they first came public and the profits we made have bought a lot of burritos. We are still attentive to what we believe is a great business model and a well run company.

The question is how much to pay for a great business model and a well run company. In today's highly risk-averse environment the answer has to be: Not Much. I believe CMG will miss consensus earnings estimates for the third quarter by at least 2 cents and guide lower for the rest of this year and next (Current estimates call for quarterly earnings of $.60/ share on sales of $340 million). I believe that this will result in a PE compression to 15X this years earnings which will give us a stock price of ~ $35. Maybe then I'll take a look at buying back in, but until then I remain short the stock.

I do have to offer a couple of caveats to anyone considering shorting the company's shares:

  1. There are better short candidates out there for new money, notably in the financial sector (as if you need ME to tell YOU that!).
  2. Chipotle has a lot of cash and no long term debt to speak of, in fact it has enough cash on hand to pay off all its liabilities as of the quarter ended June. This company is not going bankrupt or to the market for an equity raise any time soon. When shorting stock in this environment, look for companies that have a good chance of insolvency within the next 12 months. My short position was executed last spring when commodity costs and menu prices were rising, and the financial environment was far different that it is today. At best I can only advise you to stay away from this one until a better price can be had.

Stock position: Short CMG.