Are Chipotle's Shares Overpriced?

By Pam Peerce-Landers - July 10, 2012 | Tickers: CMG, JACK, PNRA | 0 Comments

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Are Chipotle Mexican Grill, Inc.'s (NYSE: CMG) shares overpriced or fairly valued?  To answer this question, I compared CMG's performance with those of two other chain restaurants whose average check sizes are similar (around $10) and also feature upscale fast food: Panera Bread (NASDAQ: PNRA) and Qdoba Mexican Grill, a wholly owned subsidiary of Jack in the Box, Inc. (NASDAQ: JACK).  Performance measures included Average Weekly Sales (AWS), Cost of Sales and Same Store Sales (SSS) Growth. Valuation is based on P/E. Since all of CMG's stores are company-owned, I only considered company-owned stores for PNRA and Qdoba.

Chipotle's Sales Outperform their Peers

Chipotle's average weekly sales (AWS) for the most recent quarter were $39,047 vs. $45,576 for Panera and $16,672 for Qdoba.  However, that is not the whole story. Panera's stores average 4,600 square feet -- nearly 80% larger than Chipotle's and over twice the size of Qdoba's.  So, to put these figures in perspective, the following chart shows AWS per square foot and also AWS per employee.  As you can see, Chipotle's AWS per square foot is significantly higher than Panera's and twice that of Qdoba's, and their AWS per employee is double both these competitors.  The difference in these figures for Chipotle vs. Qdoba is surprising considering how similar their menus are, but it shows what a powerful franchise Chipotle really is.

Chipotle's Cost of Sales is the Lowest of the Three

Cost of Sales includes food & packaging, labor, and occupancy & other.  As a percentage of sales, Chipotle's was the lowest at 72.6%, while Qdoba's was the highest at 84.4%.  As expected, Chipotle's food costs were the highest because of their emphasis on organic ingredients, but their labor costs were the lowest.  Qdoba's costs for occupancy & other were the highest -- 64% more than Chipotle's.

Same Store Sales (SSS) Growth

For any chain, same store sales (SSS) growth is a crucial measure of success.  Investors reward companies with high SSS growth by valuing their shares more highly (awarding them a higher P/E) than those of their lower performing peers.  The following graph shows the SSS growth reported by all three companies for the most recent quarter and also their P/Es as of July 6. (Note: Since Qdoba is not publicly traded, the P/E for its parent, JACK, was used.  This seemed fair because the Jack in the Box restaurants' SSS growth was 47% higher than Qdoba's and Qdoba only represented 18% of JACK's sales.)

For the most recent quarter, Chipotle reported a 12.7% increase in SSS vs. just 3.8% for Qdoba and Panera came in at 7.5%.  Interestingly, there appears to be a relationship between SSS growth and P/E.

P/E is Directly Related to Same Store Sames Growth 

Plotting these companies' P/Es against their most recently reported SSS growth, we see that the points appear to form a straight line. Indeed, when the best fit straight line is plotted to these data (linear regression), you see that there is an excellent linear correlation.  Based on this graph, Qdoba would appear to be slightly overvalued if its P/E were indeed 17.1 and PNRA would appear to be somewhat undervalued at a P/E of 28.2.  CMG looks fairly valued with a P/E of 52.7.

So, what does this mean?  Well, it means that as of July 6, all three companies were apparently valued by the market based on their relative SSS growth.  Chipotle was appropriately rewarded for its superior SSS growth and their share price was $383.49.  But on April 20, the day after they reported a 12.7% increase in SSS, their share price closed at $419.26, suggesting a P/E of 57.6 or 9% higher than Friday's close.  What happened?

As nice as that straight fit line looks, it is not a perfect predictor of share performance.  Any company's share price is also subject to macro-economic factors beyond their control.  What we can say is that if Chipotle's SSS growth were to drop precipitously to, say, 7-8%, as was recently suggested by one analyst, there would be consequences.  The above graph suggests Chipotle's share price could fall 45% if their SSS growth slowed to 7%.  But, how likely is that to happen?  Who knows, but we can look at Chipotle's management's history of SSS guidance and the actual results.

History of Chipotle SSS Guidance vs. Actual Results 

Since 2006, Chipotle has consistently grown their SSS.  Even during the Great Recession of 2009, SSS grew 2.2%.  This past quarter, growth was the highest in six years — 2006 was 11.9%, Q1 2012 was 12.7%.  Can they keep it up?  Don't know.  But, I do know that they have consistently met or crushed their annual guidance on SSS. 

As the above table shows, Chipotle's SSS met guidance in 2008 and 2009 and handily beat guidance in all the other periods shown.  Last year, they predicted a mid-single digit increase for 2012 and reaffirmed this guidance last quarter to the market's chagrin.  Historically, Chipotle's management provides SSS guidance for the coming year in their 10-K SEC filing for the year just ended.  I could not find any instance when management changed their guidance during the year.  In fact, SSS guidance for the more recent periods shown has consistently ended with the following phrase or words to that effect: "...due to difficult comparisons with [insert current year] and ongoing consumer uncertainty." 

Chipotle reminds me of Microsoft Corp. in the late 1990s.  Their stock would rise in anticipation of their earnings.  They would routinely crush estimates and then their CFO, Greg Maffei, would provide “disappointing” guidance for the next quarter and the stock would drop.

Bottom Line

Chipotle is a very well run enterprise, but today's economy is not the same as in the late 1990s.  Chipotle's stock appears to be fairly valued today relative to their peers. They report Q2 earnings on July 19.  I am content to wait given the high bar they set last quarter and the fact that twice in the 6 periods shown above, they met, but did not beat their guidance.

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