Is Now the Time to Take a Bite Out of This Restaurant Stock?

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

Last week, Chipotle Mexican Grill (NYSE: CMG) announced its first quarter results, and the company’s shares promptly rose 12%. Despite this highly favorable reaction by the market, the results were largely as expected. Revenue increased by 13% and earnings per share increased by 24%, both of which were slightly ahead of expectations. Meanwhile, same store sales rose just 1% and margins declined thanks to higher food and occupancy costs. So what drove the big jump in share price? The market’s reaction to Chipotle’s earnings was as much a reflection of analysts’ revelation that they had undervalued the company as it was the estimate-beating results.

High growth… and high volatility

Chipotle, like many high growth companies with a premium valuation, is subject to above average volatility. As a result, the company’s shares will routinely move more than the overall market, which can create quite the roller coaster for shareholders. Just six months ago, Chipotle’s shares plunged to $233 on fears of competition from Yum Brands’ (NYSE: YUM) Taco Bell new Cantina Bell menu, rising food costs, and even a questionable short call by David Einhorn. As I wrote six months ago, this reaction was overdone and created a solid buying opportunity. Since then, the stock price has recovered nicely, albeit not to the all-time highs reached a year ago:

<img alt="" src="http://media.ycharts.com/charts/07cad0bc4766ab497257cc42853df92f.png" />

CMG Total Return Price data by YCharts

A long term view is critical

The chart above is an excellent example of why patience and a long term (5+ years) mentality is critical when considering an investment in a company like Chipotle. In the big picture, what has changed in the past year since the stock spiked to over $424 per share, plunged back to $233 per share, and has increased back to over $360 per share?

In short, I’d argue that nothing has changed. Chipotle’s growth rate has begun to decelerate (as expected) as it grows in size, with 1,458 restaurants at the end of the first quarter. However, there is still room to more than double the company’s footprint to 3,000 locations in the United States. International expansion will continue to add even more growth potential, but the size of the market opportunity is far less certain at this time.

Growth opportunities exist beyond just Chipotle's location expansion. Management has announced that ShopHouse will be adding a fourth location as part of its methodical plan to perfect the relatively new concept prior to rolling it out on a large scale.

Within the existing restaurant base, Chipotle is continuing to innovate and find ways to drive future growth. Management’s highly successful trials of catering service and tofu-based “sofritas” will be rolled out to more restaurants in the coming months. More recently, Chipotle announced a new line of margaritas featuring Patron tequila. In the future, breakfast offerings may provide yet another way to drive revenue growth.

An additional driver of shareholder returns to keep in mind is the company’s share buyback program. As noted on this quarter’s earnings call, the company spent $51 million to opportunistically repurchase shares. This buyback has more than offset the dilutive effects of stock-based compensation and has reduced the overall number of shares outstanding.

Risks still remain

As noted above, Chipotle’s most recent quarterly results were not universally good news. Same store sales were weak and rising food costs cut margins, both of which had been forecast for months. These risks, combined with competition from an array of fast casual restaurants including Jack in the Box’s (NASDAQ: JACK) Qdoba and non-burrito alternatives such as Panera Bread (NASDAQ: PNRA) are worth monitoring. Additionally, the premium valuation placed on Chipotle makes the stock much more volatile; investors must have both a willingness to ride the stock’s roller coaster and also be comfortable with the current valuation.

A look at Chipotle’s valuation

With a TTM price to earnings ratio approaching 40, many investors may still be reluctant to purchase shares. While the volatility discussed above makes it difficult to time purchases of Chipotle perfectly, the current valuation is right in the middle of the historical range as illustrated by the following chart:

<img alt="" src="http://media.ycharts.com/charts/df4281d551927750078a82a5bb88d1b9.png" />

CMG PE Ratio TTM data by YCharts

In addition to being within the historical range for Chipotle’s valuation, the company is trading at valuation multiples that are comparable to other best-in-class specialty eateries like Panera and Starbucks (NASDAQ: SBUX).  Panera and Starbucks are both trading at a slightly more attractive valuation at today’s prices, but given Chipotle’s history of volatility it is quite likely that there will be another opportunity to buy shares at a trailing P/E of 30 or less at some point.

Meanwhile, the fact that all three companies have been successful is a strong affirmation that the market for food that is a step above the fast food offerings of Yum Brands and McDonald's continues to strengthen as more people focus on eating foods with higher quality ingredients. The gap in share price performance between Chipotle, Panera, and Starbucks and their fast food competition reflects this reality:

<img alt="" src="http://media.ycharts.com/charts/48bc8f1b4132706dd0fa07d499cffb1e.png" />

CMG Total Return Price data by YCharts

Is Chipotle a buy?

There have been no new developments that would lead to a change in the long term conclusion that Chipotle is a Top 10 stock. Is it a screaming buy today? Not quite, especially given the relative softness of same store sales in recent periods compared to Chipotle’s history of double digit increases. Despite this yellow flag and ongoing consideration of the company’s valuation, a strong case can be made that the company can continue to outperform the market over the long term given the company’s growth opportunities, excellent management, and fantastic products. For these reasons, Chipotle remains a compelling stock for consideration as a long-term investment.

 


Brian Shaw owns shares of Chipotle Mexican Grill and Starbucks. The Motley Fool recommends Chipotle Mexican Grill, McDonald's, Panera Bread, and Starbucks. The Motley Fool owns shares of Chipotle Mexican Grill, McDonald's, Panera Bread, and Starbucks. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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