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Would you Like Guacamole or Curry with That?

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To follow up on my recent bearish valuation analysis of Chipotle Mexican Grill (NYSE: CMG), it is time to take a look at the reasons that the sky may not be falling quite yet for this classic rule breaker.  Most will agree that the stock is expensive based on Chipotle's most recent results, but the more important question for investors today is: how will Chipotle's stock perform over the next 5 years or more?  Let's take a look at a few reasons to be excited...

Growth is NOT Over Yet!

While I will agree that Chipotle cannot continue to grow the number of its restaurants in the U.S. by 15% or more per year forever, we're still far from the end of the growth story.  As of Q1 2012, Chipotle had 1,262 restaurant locations.  The general consensus is that Chipotle can expand in the U.S. to somewhere between 3,000 and 3,500 locations.  Now stop and think about that for a minute; the expectation is that Chipotle can almost triple in size in the U.S.  That means that Chipotle can continue to add locations at its current pace of 155-165 in 2012 and continue strong growth for the next 10 years.  Here are two overly simplified examples of how this growth translates into a stock price using a model that differs from many that you will see:

Assumptions:

  • 160 store openings per year - assumed to contribute 1/2 of a year's worth of revenue in first year of each opening.
  • 5% or 10% same store sales increases per year - the actual increase was 11.1% in the most recent quarter and has been 10% or greater each of the past 6 quarters.  However, 10% is an aggressive assumption for a restaurant to maintain over time.
  • EPS will grow on pace with revenue - EPS has typically grown faster (29.5%) than revenue (24%) over the past 6 years, but there are many reasons not to expect this trend forever.
<table> <tbody> <tr> <td><strong> </strong></td> <td><strong> </strong></td> <td colspan="2"><strong>Scenario 1 - 5% SSS Growth </strong></td> <td colspan="2"><strong>Scenario 2 - 10% SSS Growth </strong></td> </tr> <tr> <td><strong> </strong></td> <td><strong>Stores</strong></td> <td><strong>Revenue (in billions)</strong></td> <td><strong>EPS</strong></td> <td><strong>Revenue (in billions)</strong></td> <td><strong>EPS</strong></td> </tr> <tr> <td>2012</td> <td>1390</td> <td>2.53</td> <td>7.54</td> <td>2.64</td> <td>7.88</td> </tr> <tr> <td>2013</td> <td>1550</td> <td>2.80</td> <td>8.35</td> <td>3.06</td> <td>9.12</td> </tr> <tr> <td>2014</td> <td>1710</td> <td>3.09</td> <td>9.20</td> <td>3.52</td> <td>10.50</td> </tr> <tr> <td>2015</td> <td>1870</td> <td>3.39</td> <td>10.09</td> <td>4.04</td> <td>12.04</td> </tr> <tr> <td>2016</td> <td>2030</td> <td>3.70</td> <td>11.02</td> <td>4.62</td> <td>13.76</td> </tr> <tr> <td>2017</td> <td>2190</td> <td>4.03</td> <td>12.01</td> <td>5.26</td> <td>15.68</td> </tr> <tr> <td>2018</td> <td>2350</td> <td>4.38</td> <td>13.05</td> <td>5.98</td> <td>17.82</td> </tr> <tr> <td>2019</td> <td>2510</td> <td>4.75</td> <td>14.14</td> <td>6.78</td> <td>20.21</td> </tr> <tr> <td>2020</td> <td>2670</td> <td>5.14</td> <td>15.30</td> <td>7.68</td> <td>22.87</td> </tr> <tr> <td>2021</td> <td>2830</td> <td>5.55</td> <td>16.53</td> <td>8.67</td> <td>25.84</td> </tr> <tr> <td>2022</td> <td>2990</td> <td>5.98</td> <td>17.82</td> <td>9.79</td> <td>29.16</td> </tr> <tr> <td> </td> <td> </td> <td> </td> <td> </td> <td> </td> <td> </td> </tr> <tr> <td colspan="2"><strong>2022 Share Price</strong></td> <td> </td> <td> </td> <td> </td> <td> </td> </tr> <tr> <td> </td> <td> </td> <td>15 P/E</td> <td>     267.28</td> <td> </td> <td>     437.36</td> </tr> <tr> <td> </td> <td> </td> <td>20 P/E</td> <td>     356.37</td> <td> </td> <td>     583.14</td> </tr> </tbody> </table>

So, this very simplified analysis seems to say that Chipotle will be worth somewhere between $267 and $583 per share in 10 years.  Wait... I thought this was supposed to be a bull argument?!?!  It is, and here's where my logic starts to depart from the consensus of the investment community.

3,000 Locations is NOT the Limit

For many of the established restaurant chains, the big growth story over the past decade has not been in the U.S.  Instead, these companies are finding growth internationally.  For example, over 14,000 of McDonald's (NYSE: MCD) 33,000 locations worldwide are outside the U.S.  Over 4,000 of KFC's (owned by Yum Brands (NYSE: YUM) 17,000 locations are in China alone.  These numbers continue to grow dramatically each year.  How about Chipotle?  As of the end of 2011, Chipotle had 4 international locations: 2 in London and 2 in Toronto.  This is just the tip of the iceberg.  Management has demonstrated their usual discipline and has used a small number of locations to test the concept and begin to understand how it may need to be modified to accommodate consumers' varying preferences in other countries.  

I will be the first to admit that how fast international growth will occur and how successful it will be in various countries is virtually impossible to guess.  However, management plans to take on this challenge in a smart, deliberate way.  On the Q1 earnings call, management indicated that it plans to open 2 additional locations in London and 1 location in Paris during 2012.  I'll leave it to the individual investor to figure out whether the international opportunity will add 50, 500 or 5,000 locations to Chipotle over time, but the key takeaway is that there is tremendous opportunity to add to the total number of locations outside the U.S. and Chipotle's management wants to get it right.

A New Recipe for Success

There is another growth vehicle that is often discounted: a new restaurant concept.  Last fall, Chipotle opened a second restaurant concept called ShopHouse Asian Kitchen.  While this concept still only has one location, there is certainly the intent to develop and roll out this restaurant to additional locations.  Again, predicting how many and how successful ShopHouse will be is a guessing game at this point.  However, favorable early reviews combined with a management team that is focused on perfecting the concept and then expanding in a disciplined manner are reasons to expect big things.  

An Illustration of the Opportunity

Using the simplified example above, consider the effects of adding 500 ShopHouse and 500 international locations to the valuation over 10 years.  Suddenly, a P/E of 20 would support a share price of $670 in 2022, which represents a 5.8% CAGR from the July 11 closing price of $380.47.  What if the company can add 1,000 ShopHouse and 1,000 international locations?  Suddenly, that $670 jumps to $750, which is a 7.0% CAGR from the current stock price. 

The point of this exercise is not to create a comprehensive model to predict the future, but simply show that Chipotle can withstand a massive P/E compression from 52.6 today to 20 in the future and still generate positive returns for investors along the way. Will there be multibagger returns going forward?  Not likely based on the information that is currently available (which is, of course, subject to change), but there is certainly more money to be made in the burrito business.  


BrewCrewFool owns shares of Chipotle Mexican Grill and will gladly pay an extra $1.80 to have guacamole on his burrito. The Motley Fool owns shares of Chipotle Mexican Grill and McDonald's. Motley Fool newsletter services recommend Chipotle Mexican Grill, McDonald's, and Yum! Brands. 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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