You mean Chipotle ISN’T perfect???

By Brian Shaw - July 24, 2012 | Tickers: BWLD, CMG, PNRA, SBUX | 0 Comments

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Just over a week after posting some thoughts on the bear and bull arguments for Chipotle Mexican Grill (NYSE: CMG), the company’s second quarter results sparked an eye popping sell-off of over $86 per share (or 21.5% of CMG’s value).   This marks the worst single day performance in Chipotle’s history as a public company.  A drop in share price from $442.40 to $316.98 in just a few months is worth taking a deeper look into.

So What Went Wrong?

Chipotle’s second quarter results featured a 21% increase in revenue and 61% increase in EPS.  While the EPS growth is impressive and massively beat analyst expectations, Chipotle missed analyst expectations on revenue ($690.9 million versus the $707.1 million analysts’ estimate).  Along with the revenue miss, same store sales increased just 8% (which is by no means a bad result, but lagged both expectations and Chipotle’s recent double digit performances) and management made some cautious statements regarding customer traffic.  In combination, these top line pressures and the rising costs of food burst the bubble of a stock that many have said has been “priced for perfection.” 

Aftershocks Felt Across the Industry

The suddenly negative analyst sentiment towards Chipotle was felt across the restaurant industry.  On a day where the S&P 500 was down 1%, fellow casual restaurant chains Buffalo Wild Wings (NASDAQ: BWLD) and Panera Bread (NASDAQ: PNRA) dropped 3.5% and 3.8%, respectively.  In fact, most of the restaurant industry lagged the market on July 20^th precisely because of what analysts read between the lines of Chipotle’s earnings release and conference call.  In particular, the market is extra sensitive to a potential slowdown in traffic at casual restaurants given the fragile state of the economy.  A notable consumer trend toward downgrading from restaurants like Chipotle to traditional fast food or to skip eating at restaurants altogether would be a major threat to Buffalo Wild Wings, Panera and others.   In fact, companies such as Starbucks (NASDAQ: SBUX), which fell 4.1% on Friday, are even more vulnerable to widespread changes in consumer spending habits than Chipotle given that their core products are premium-priced discretionary items that are not necessarily a part of the core three meal per day food consumption pattern observed by many Americans.

A Sharp Change in Valuation

Given the strongly negative reaction to Chipotle’s earnings, it makes sense to translate the decline in share price into metrics that many investors use to evaluate companies.  Here is a side-by-side look at some common valuation metrics for Chipotle, and how they have changed in just one week:

 
What to Do Now

Clearly, the valuation of Chipotle’s shares has become more attractive after the post-earnings decline.  However, shares are still far from being considered cheap by most conventional metrics, so the real decision for investors remains focused on Chipotle’s growth trajectory going forward.  Management continues to estimate that 155 – 165 new locations will open during 2012, of which 54 opened during the second quarter.   Is that level of domestic expansion, combined with mid-single digit same store sales growth, enough to justify an investment?  What if Chipotle rolls out a breakfast menu, which it alluded to in the earnings call, or significantly ramps up international expansion?   If a potential investor didn’t believe in Chipotle’s growth story before, the recent drop in share price and current valuation shouldn’t be enough to convince anyone to take the plunge and purchase shares; Chipotle's shares are clearly not anywhere near value investing territory.  However, if you believe in the growth story laid out in my recent bull argument, then the recent drop in share price to more sane levels should make the current price a reasonable point to enter into a position or add to an existing one.

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