Does Chipotle's Recent Weakness Offer a Tasty Treat?
Steve is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In a recent posting I evaluated the management of Chipotle Mexican Grill (NYSE: CMG) in terms of the alignment of their interests with shareholders, returns on invested capital they have produced, and compensation they have taken for their effort. I will continue by examining the company’s operating metrics including revenue and cash flow growth, profitability, and asset efficiency to assess the prospects for continued share price appreciation.
Chipotle’s competitors in the fast-casual restaurant segment include Jack In the Box, Inc. (NASDAQ: JACK), which operates fast casual restaurant chain Qdoba, Panera Bread Company, Inc. (NASDAQ: PNRA) and Brinker International, Inc. (NYSE: EAT), operator of Chili's and Maggiano's Little Italy.
After posting average annual earnings per growth of 29.5% since 2005, consensus estimates suggest that more of the same is expected for Chipotle. Earnings per share growth is estimated at more than 30% and almost 25%, respectively, in 2012 and 2013. Investors have been paying up for this strong earnings growth as reflected in the price to earnings to growth ratio (PEG). For 2013, the PEG multiple is 1.43x at a recent price of $393, well in excess of Panera and Brinker at recent 2013 PEG multiples of 1.08x, and 0.8x, respectively, but lower than Jack in the Box at 1.63x. Unlike Chipotle, Jack in the Box is actually projected to see earnings decline from 2011 so while Chipotle’s PEG multiple is at the high end of its peers, it is still comfortably within the 1.0x to 2.0x range that I seek for fast growers. If the estimated growth rates are actually achieved, investors should expect Chipotle’s shares to continue to perform.
We need to examine recent trends in revenue, margins, and cash flow along with competitive advantages and risks to assess the likelihood that Chipotle will grow earnings as estimated. Also, the company's operating cycle and asset turnover efficiency give insight into how well management is utilizing its operating and fixed assets, which directly impact cash flows and the growth rate.
The compound annual growth rate of revenue slowed from more than 41% from 2002 through 2006 to about 22.6% from 2006 through 2009 and has flattened out at 22.2% for the past two years. The consensus earnings estimate is based on compound annual revenue growth of 19.8% through 2013 which is plausible given the historic trends, new growth opportunities such as the ShopHouse Southeast Asian Kitchen concept started in 2011, and some estimates of the company's saturation point at 3,500 stores or almost 2x above its current 1,230 store count.
Chipotle has been able to improve its operating margin to a stable range of 13% to 15% in the past three years from 7.5% in 2006 and 1.3% in 2004. In my opinion, this long term improvement, which is driven partly by low employee turnover rates and consistent customer experiences is very bullish for the predictability of forward earnings. In-house manager and assembly line crew development programs are aiding the low employee turnover rate and consistent customer experiences.
One of Chipotle’s main competitive advantages is its use of fresh ingredients as a source of product differentiation. This differentiation strategy carries with it the risk of possible food shortages for Chipotle because there are fewer suppliers of naturally raised beef, chicken, and pork. Other risks faced by Chipotle and its peers are: the fast-casual restaurant market is at risk of being flooded by new entrants lured by unoccupied (and thus cheap) real estate and easier access to capital; Mexican style menus currently comprise more than 20% of the fast-casual restaurant industry in the United States; a still sluggish consumer environment; minimum-wage increases; and volatile commodity costs.
The compound annual growth rate of operating cash flow slowed from just less than 36% from 2006 through 2009 to about 25.5% for the past two years. I find it very encouraging that the growth rate in operating cash flow has remained several percentage points above the growth rate of revenue and has moved closer to the growth rate of earnings per share.
Chipotle's management has been able to effectively manage its assets while achieving its outstanding growth. Fixed asset turnover has improved to an average of about 2.8x over the past 3 years from an average of about 2.4x since 2004. This is better than Jack in the Box at 2.6x and Brinker at 2.4x but trails Panera at 3.6x. Likewise, total asset turnover has improved to an average of about 1.8x over the past 3 years from an average of about 1.7x since 2004 which is better than Jack in the Box and Brinker at 1.6x each and comparable to Panera at 1.8x.
In summary, because of Chipotle’s room to grow store count, stabilized profit margins from management initiatives, new restaurant concepts, and differentiation strategy, I give earnings estimates for 2012 and 2013 a good probability of being achieved so I am modestly bullish on the shares at PEG ratios below 2.0x for this fast grower.
56Steve has no positions in the stocks mentioned above. The Motley Fool owns shares of Chipotle Mexican Grill and Panera Bread. Motley Fool newsletter services recommend Chipotle Mexican Grill, Jack in the Box, 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.If you have questions about this post or the Fool’s blog network, click here for information.