You Can Still Join Einhorn’s Side on This Stock

Anjali is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

David Einhorn’s bearish presentation on Green Mountain Coffee Roasters (NASDAQ: GMCR) at the Value Investing Conference last year made him an instant hero among Wall Street professionals. Green Mountain Coffee Roaster’s stock has corrected more than 70% since then. He still remains bearish on GMCR citing its capital expenditure, doubtful accounting practices and unfavorable competitive landscape. However, there is another consumer stock where Einhorn's bearish bet is garnering more attention off late. At this year’s Value Investing Conference he has “EinhornedChiptole Mexican Grill’s (NYSE: CMG) stock. Chipotle is a restaurant company and serves Mexican food which includes a menu of burritos, tacos, burrito bowls (a burrito without the tortilla) and salads. The stock fell from $313 to $293 within seconds of Einhorn’s presentation.

Figure 1: The Einhorn effect

 

<img src="/media/images/user_13682/cmg1_large.png" />

Source: Google Finance

Einhorn’s main bearish argument is that Chipotle is losing market share to YUM Brand’s (NYSE: YUM) Taco Bell. Taco Bell has recently launched its Cantina Bell and Doritos Locos Tacos menu which provides a cheaper and better alternative to Chipotle’s offering. Even if we look at third party consumer perception survey companies like YouGov BrandIndex, Taco Bell has gained a good traction since the new menu launch and consumer perception of Taco Bell has improved dramatically since July.

 

<img src="/media/images/user_13682/cmg2_large.png" />

Source: YouGov BrandIndex

What David Einhorn presented was not entirely a new thing. There were visible signs that Chipotle is losing ground to taco bell after last quarter’s earnings result. While Chipotle reported 8% SRS (Same Restaurant Sales) increase in Q2, Taco Bell reported a 13% increase. However, one thing which makes David Einhorn’s presentation significant is that the stock market is yet to price in the complete impact of this market's share loss. There are two main drivers which are likely to cause the stock downside going forward.

  • Multiple Compression

Chipotle is trading at a forward PE of 25.77 even after the recent correction. This is way higher than the established restaurant fast food companies like YUM Brands and McDonalds which are trading at forward PE's of 17.65 and 15.27 respectively. Given the fact that Chipotle is losing market share in its particular category, this premium looks unjustified. Even if we believe sell side estimates and assume Chipotle will be able to deliver 21% growth next year, its PEG ratio still comes to be greater than 1 making it expensive on a PEG basis.

  • EPS expectation is yet to come down

According to Yahoo! finance estimates, Chipotle is expected to grow its EPS at 21.22% per annum for the next 5 years. I believe this number has to come down as analysts start pricing in Chipotle’s market share loss story. The company’s SRS has already shown a slow down in last quarter. SRS slowdown hurts in two ways. On the one hand, it reduces the profit per store expectation and on the other it makes management more cautious while opening new restaurants. Sell side estimates for Chipotle’s next year’s earnings have already come down from 11.09 to 10.90 in the last 90 days and I believe this is just the beginning of the trend. As there is more evidence of Chipotle losing ground to Taco Bell, this downward trend will continue. 

I believe with the multiple getting compressed and an EPS decline would cause a good amount of further downside in the stock. In addition there are other concerns like Chipotle's questionable employment practices and commodity inflation which will prove to be a headwind for the stock. For those who are looking to short, I believe there is a good amount of downside still left in the stock and Chipotle may soon become a secular market share decline story. I would recommend short selling the stock at current valuations as the risk reward are still on the downside. 


AnjaliPaliwal has no positions in the stocks mentioned above. The Motley Fool owns shares of Chipotle Mexican Grill and has the following options: long DEC 2012 $16.00 puts on Green Mountain Coffee Roasters and short DEC 2012 $21.00 calls on Green Mountain Coffee Roasters. Motley Fool newsletter services recommend Chipotle Mexican Grill and Green Mountain Coffee Roasters. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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