Don't Take a Bite of This Burrito Maker Until It Cools Off
Fast-casual Mexican chain Chipotle Mexican Grill has attracted rabid fans in a way that few restaurants can. Chipotle prides itself on using natural ingredients and classic cooking techniques to serve (relatively) healthy food. Chipotle's focus on quality has helped it build a large loyal following and thereby keep its restaurants packed despite prices that are higher than those of most fast-food restaurants.
Chipotle has had a bumpy ride in 2013, accentuated by relatively weak sales growth early in the year. However, the company has made a big comeback in the past few months, and returned to strong revenue growth last quarter. This sent the stock soaring to a new all-time high just above $500 by the end of the day on Friday.
While I'm a big fan of Chipotle's mission and food, I can't recommend the stock to investors until it cools off. I think the company has a good chance to grow its earnings by 20% (or 25%, in a best-case scenario) per year on average over the next five years, but that's already fully reflected in Chipotle's high multiple of 38 times 2014 earnings estimates.
Chipotle has almost as many fans on Wall Street as it does in its restaurants. Still, some investors are not convinced by its growth story. In fact, Chipotle has been a bit of a battleground stock for the past year.
Skeptics like hedge-fund manager David Einhorn have argued that Yum! Brands' chain Taco Bell would lure less-affluent Chipotle customers away with its new, higher-quality "Cantina Bell" menu. Einhorn reaffirmed this short thesis within the last week, arguing that Taco Bell has indeed been gaining share from Chipotle among younger diners.
Nothing to complain about
However, Chipotle's recent earnings release should put these fears to bed. Sales in restaurants open for at least a year grew by 6.2%, even though Chipotle hasn't raised prices recently. On a company-wide basis, revenue grew 18% as Chipotle continued to open new restaurants. This drove a 17% increase in earnings per share to $2.66.
Investors had other reasons to be encouraged. On the company's earnings call, CFO Jack Hartung stated that comparable restaurant sales -- which have been improving all year since a relatively weak first quarter -- would likely improve again in the fourth quarter.
Furthermore, Hartung told investors to expect a menu price increase in the 3% to 5% range sometime next year, around the time that Chipotle finishes removing genetically modified organisms from its food. This should offset cost increases that have weighed on the company's margins recently.
It's all about the valuation
Chipotle put up a solid performance last quarter, and it has a good chance to keep up its momentum going forward. Nonetheless, I'm skeptical that the stock is really worth $500.
Chipotle has earned about $10 per share in the last 12 months. Its strong revenue growth and good margins should allow for continued earnings growth in the 20% to 25% range for a while. However, Chipotle's growth rate will probably moderate within the next few years.
Chipotle has been growing its restaurant count by about 12% annually in recent years. By the end of 2013, Chipotle will have almost 1,600 total restaurants. If it continued growing at a 12% pace, that total would balloon to about 2,800 in five years and nearly 5,000 in 10 years. I am skeptical that Chipotle will be able to grow this quickly without undermining its profitability. As the growth rate tails off, Chipotle's earnings multiple is likely to contract quite a bit.
The one factor that could help the restaurant chain grow into its stock price is demonstrating a major success outside of its core domestic Chipotle business. If the Chipotle concept becomes equally successful in foreign markets, or if Chipotle's new ShopHouse Southeast Asian Kitchen concept takes off, it could provide a new growth driver for the company. This might offset the eventual saturation of the U.S. market with Chipotle outlets.
Chipotle is a great company that has rewarded long-term investors handsomely. However, today's stock price is quite generous considering the company's likely growth prospects. I think Chipotle will have a hard time living up to investors' high standards over the next five to 10 years, and so I see limited future upside for the stock. Accordingly, I've entered a thumbs-down call in my CAPS profile.
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The article Don't Take a Bite of This Burrito Maker Until It Cools Off originally appeared on Fool.com.Fool contributor Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. 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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