Is This Restaurant a Sizzling Deal or a Gristly Morsel?


Shares of Chipotle Mexican Grill (NYS: CMG) hit a 52-week low on Monday. Let's take a look at how it got there and see if cloudy skies are still in the forecast.

How it got there
The final pillars of strength are falling in the restaurant sector. For months, despite rising food prices and waning consumer spending, McDonald's (NYS: MCD) and Chipotle have easily stood above their peers. Both companies had been able to consistently surpass same-store sales estimates, boost pricing when needed, and utilize their diverse menus to drive customer traffic.

All of that can be officially thrown out of the window. If you thought Chipotle's last quarter was an aberration, then its third-quarter results proved otherwise. Revenue did rise by a healthy 18.4%, but comparable-store sales growth of 4.8% and EPS of $2.27 both missed the mark.

One of the reasons Chipotle is struggling has to do with its stance on keeping its prices firm. As management noted, it suffered a 330 basis-point hit because it's balked on raising its prices in 2012. That's good news from a consumer perspective and should drive traffic into Chipotle restaurants, but it's bad news over the near-term for Chipotle's margins, which are being pinched by food inflation costs.

Another reason Chipotle took another dive has to do with its weak outlook for 2013. Historically, Chipotle's comparable-store sales have been in the high single digits, but its forecast for 2013 calls for same-store growth to be flat or in the low single digits. I've long claimed that Chipotle's growth rates were destined to flatten out, and we're beginning to see this come to fruition.

How it could get its swagger back
There are a lot of factors working against Chipotle, like rising food costs, less money for consumers to spend, and plenty of competition, but there's also a lot that could change its fortunes.

For one, Chipotle has found success in offering healthier and ethical food options for its patrons. While offering food in this manner isn't cheap, it's proven to be a success across the entire food supply chain. Grocer Whole Foods Market (NAS: WFM) and organic and natural food producer Hain Celestial (NAS: HAIN) both charge a premium for their products, yet consumers will willingly pay those higher costs for the perception of receiving food that's more nutritious. Unsurprisingly, Whole Foods and Hain Celestial have largely bucked the margin crunch associated with food inflation.

Another factor working in Chipotle's favor is its pristine balance sheet, which features $573.9 million in cash and a puny $3.6 million in debt. This cash position gives it the ability to expand internationally and domestically as it sees fit and pounce on opportunities its peers may not be able to. Casual-dining restaurant Ruby Tuesday (NYS: RT) , on the other hand, has considerably more debt than cash, has produced positive comparable-store sales only once in the past seven quarters, and is closing restaurants while Chipotle is rapidly opening them. Chipotle is really in better financial position than a vast majority of its peers.

What's next
Now for the $64,000 question: What's next for Chipotle Mexican Grill? That really depends on how it plans to improve its margins and drive traffic into its restaurants.

Our very own CAPS community gives the company a two-star rating (out of five), with 85% of members expecting it to outperform. Currently, my underperform CAPScall on Chipotle is up a whopping 44 points, and I won't be looking to close it anytime soon.

A lot of Wall Street pundits have called this drop a potential bargain price for Chipotle. I have to wonder if they're looking at the same company I am. Even after the drop, Chipotle still commands a forward P/E of 21 despite a projection of flat-to-low single-digit growth in comparable-store sales in 2013. In June I also hit on a valuation point with regard to Chipotle's relative market value per restaurant compared to its peers. After the drop, Chipotle's restaurants still command more than double that of McDonald's, yet Mickey-D's boasts the better margins of the two, by far! Unless I see evidence of better consumer spending and a tapering in food inflation, I'll continue to believe that Chipotle could be in for further rough times.

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Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.The Motley Fool owns shares of Chipotle Mexican Grill, McDonald's, and Whole Foods Market. Motley Fool newsletter services have recommended buying shares of Chipotle Mexican Grill, McDonald's, Whole Foods Market, and Hain Celestial, as well as creating a bull call spread position in McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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