Chipotle Mexican Grill (CMG: Charts, News, Offers) has consistently been an industry-defying company, with a stock climbing faster than Apple’s (AAPL: Charts, News, Offers) and a P/E rivaling the most speculative tech companies. At $300, Chipotle now trades with a trailing P/E of 51.75 and a price-to-book ratio of 11.68, the most overbought in the restaurant industry. At each step up, bearish analysts have claimed that Chipotle would teeter off the edge of a precarious cliff; however, Chipotle has defied the odds (and gravity) by climbing from the low $40s in five short years. Now, with Greek worries swept under the table for the time being and oil prices slipping, investors wonder if Chipotle has what it takes to stage another rally in July – which has traditionally been one of the best months in the market.
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Chipotle’s strength is that its niche in the market – fast-casual Mexican restaurants – isn’t as saturated as other quick service chains, which usually cater to the typical burgers and fried chicken market. Chipotle’s prides itself on the higher quality of its food in comparison to Yum! Brands’ flagship Taco Bell, which Taco Bell CEO Greg Creed likened to “comparing a BMW to a Hyundai.” While Chipotle’s products are more expensive, the company’s sales prove that consumers are willing to pay, and better yet, there are few competitors in the field of higher-end Mexican fast food. Jack in the Box’s (JACK: Charts, News, Offers) fledgling Qdoba Mexican restaurant is a new entrant to the field, which Chipotle dominates.
Chipotle’s earnings per share have been on the rise since 2001, declining only once in 2006 by a narrow margin. The company’s full-year EPS has since increased from -$1.49 in 2001 to $5.64 in 2010, achieving profitability in 2004, when it posted earnings of 8 cents per share. Most notably, the company weathered the financial crisis of 2008-2009 with increasing earnings per share ($2.36 and $3.95) in both years. Chipotle’s return on equity is far stronger than its industry peers, steadily increasing from -19.4% in 2001 to 23.53% in 2010. ROE declined slightly in from 2007-2008, but has since increased 79.5%. On average businesses return 12% on equity, with exceptional ones offering 15% or more. The company also has no long-term debt. In addition, the company also posts no R&D costs, only capital expenditures related to new store openings and expanding its current business. The company also has 68.3 million in cash on hand with a positive cash flow. These are all strong cases for the long-term viability of the company, but investors are concerned that the stock price may be getting ahead of itself.
Bears claim that the company’s restaurants open at $1.4 million, reaching maturity at $1.8 million in several years, and the only way to sustain the company’s growth is to open more units, which will lead to over-saturation and a thinning of profits. They also point out that the company’s guidance for 2011 stated that it would post “low single-digit” same-store sales increases, indicative of a transition from a growing company into a mature one. The product, at $10-$12 a meal, is not cheap and may be vulnerable to any drop in discretionary spending. Higher gas prices will also crimp the consumer’s purchasing power of premium fast food, and will benefit restaurants such as McDonald’s (MCD: Charts, News, Offers) and Yum! Brands, which offer $1 value menus. With the increasing price of food products – especially for beef, avocado and corn – the company’s insistence of using only organic and natural products may cut deeply into its restaurant-level gross margins, which dropped from 26.1% in 2010 to 25.2% in the first quarter of fiscal 2011. Chipotle announced that its food costs would come in between 32-35% this quarter, up from the 32% it posted last quarter. The first symptoms are already surfacing – this week, the company announced that it would raise menu prices in the Northeast and Southeast over the next few weeks. Another sore spot for the company is the immigration probe regarding illegal immigrants employed by the company. The government now requires Chipotle’s to implement new technology for background checks, which is expected to cut into the company’s bottom line this quarter.
On average, the price target of analysts rests at $286, $20 below its current trading price, with the high target at $375 and a low target of $195. Investors looking to build a position in Chipotle may want to take a small bite before ordering the whole enchilada, to slowly dollar cost average into this traditionally volatile growth stock.
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Leo Sun is long-time market follower and finance writer. He regularly contributes to the Stock of the Day analysis.
