This Restaurant Chain Is a Little Too Expensive

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

With sales up almost tenfold over the past decade, Chipotle Mexican Grill (NYSE: CMG) is unquestionably one of the fastest-growing food-service companies in the market. With about 1,400 restaurants currently, mainly in the U.S., Chipotle still has plenty of room for growth, particularly in international markets, an area the company is just beginning to explore. My only concern is that maybe a lot of the growth potential of Chipotle is already priced into the stock, that is, maybe the market is just a little too optimistic. Is there still room for Chipotle to rise, or could you put your investment dollars to better use elsewhere in the fast-food business?

The growth of Chipotle

As the revenue chart shows, Chipotle has grown at a tremendous rate over the years and has successfully earned a reputation of offering high-quality food at fast-food prices. The company prides itself on only serving naturally raised meats and fresh produce, which are part of its 'food with integrity' philosophy. 

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Chipotle is part of a very rapidly growing segment of the food-service industry known as “fast casual,” which reflects the shifting tastes of the American public toward healthy food at low prices that is served quickly. Over the past several years, fast-casual restaurants have seen their sales grow at double-digit rates as opposed to other restaurant categories, whose sales have averaged a 1% to 2% decline in recent years.

What is most remarkable is that Chipotle’s sales growth has not slowed down at all, even over the peak recessionary period between 2008 and 2010. In fact, the chart above indicates that revenue growth actually accelerated during that time period.

My main worry with Chipotle is that too much growth may be priced into shares right now. Chipotle trades at just under 40 times trailing-12 months earning, which by itself isn’t too uncommon for a rapidly growing company. Chipotle is projected to earn $10.62 per share this year, rising to $12.72 and $15.40 in 2014 and 2015, respectively. This translate to average annual forward earnings growth of 20.8%, which is great but I’m not sure if it justifies such a high valuation.

I’m also a bit skeptical about how long Chipotle can keep up this growth rate. As more and more of the company’s restaurants open, it will become more difficult to sustain the high growth. For example, for 20% growth, the company would have to open 280 stores this year based on the current store count. This seems manageable, but next year the company would need to open 336 stores to simply maintain the same rate of growth. You can see how this rate of expansion will get more difficult over time.

Alternative 1: McDonald’s

As an alternative, let’s first look at McDonald’s (NYSE: MCD), the world’s largest fast-food chain in terms of revenue. Despite McDonald’s size, it has proven that it can still grow and adapt and recently the company has done a great job of transitioning its menu to offer healthier alternatives to accommodate consumers’ changing tastes. 

McDonald’s currently trades for 18.2 times trailing-12 months earnings, and is projected to grow those earnings at just under 10% going forward. In addition to the stability and security that comes with McDonald’s dominant presence, investors also get a very nice income stream. McDonald’s pays a dividend yield of 3.1%, which is sure to attract income-seeking investors. The company has also raised its dividend every year in recent history, and with a payout ratio of less than 50% should be able to maintain this trend.

Alternative 2: Panera

Panera Bread (NASDAQ: PNRA) is another major player in the “fast casual” space, with about 1,650 bakery-cafes that sell only organic and natural products. Panera serves mainly breakfast and lunch, and unlike Chipotle, franchises its restaurants, which has been another major driver of growth in recent years.

Panera is worth a look because it is valued more reasonably than Chipotle while experiencing a very similar growth rate. Panera is projected to earn $7.04 in EPS this year, which is up 19.5% from last year. Its earnings are expected to increase to $8.15 and $9.81 in 2014 and 2015, respectively, for a three-year forward growth rate of 18.6%. Panera trades at 30.5 times earnings, a significantly lower valuation than Chipotle, and much more attractive for a company with a growth rate of nearly 20%.

Buy, sell, or hold?

While I love Chipotle as a company and think that its growth will continue for years, albeit at a somewhat slower rate as time goes on, I think that shares may have gotten a little ahead of themselves. I would wait for a significant pullback before jumping in, or I would feel more comfortable investing in one of the not-so-expensive alternatives mentioned here.

Chipotle's stock has been on an absolute tear since the company went public in 2006. Unfortunately, 2012 hasn’t been kind to Chipotle’s stock, as investors question whether its growth has come to an end. Fool analyst Jason Moser’s premium research report analyzes the burrito maker’s situation and answers the question investors are asking: Can Chipotle still grow? If you own or are considering owning shares in Chipotle, you’ll want to click here now and get started! 

Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill, McDonald's, and Panera Bread. The Motley Fool owns shares of Chipotle Mexican Grill, McDonald's, and Panera Bread. 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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