Harkening to the Einhorn

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 A sound is heard on yonder knoll.  It is the sound of an Einhorn, signaling to all that the end is near.  The time of Chipotle Mexican Grill (NYSE: CMG) has come.  Sell Chipotle and move on.  Two days after Einhorn's recommendation the stock fell $6.66.  Coincidence?  Outrageous—there are no coincidences.  It's the end of the world.

Ok, maybe not.  What happened is simply that David Einhorn recommended that investors sell Chipotle short.  Since this suggestion, we have seen the stock price fall significantly.  While writing this article I saw the stock price dip below $280/share. This, just a couple months ago, was absolutely unthinkable.  The last time we saw this stock under $280 was back in August 2011.   

What reason could possibly be given to justify this stock price situation?  In my mind there are a couple of possible explanations:

  1. The company has not grown in the past 14 months
  2. The company was overpriced and therefore in need of a price adjustment
  3. The company is in big trouble

Company Growth

As soon as you step back to examine the first possibility, you realize how absurd it was to have thought it in the first place.  The past 14 months have not just seen growth from Chipotle, they have seen epic growth.  The company opened 150 new locations in 2011, and that wasn't a one-hit wonder—Chipotle opened 55 new locations just in the second quarter of this year.  

Internationally, the company has new ventures.  Toronto was the first international location and has "surpassed expectations."  The Paris location is now a reality, and a hit.  Just check out some pictures of the lines.  Next on the international expansion docket is Germany.  

So the growth has been fantastic and still is fantastic. But how does the revenue growth compare to that of others in the business?  Last year, Cramer was loving the growth prospects of Buffalo Wild Wings (NASDAQ: BWLD), Texas Roadhouse (NASDAQ: TXRH), and BJ's Restaurants (NASDAQ: BJRI).  I have put these businesses in the chart below for comparison purposes.  I have also thrown in another player, Ruby Tuesday, to show that it's not always easy to experience good or killer growth, and indeed not all companies achieve it.

<img src="http://media.ycharts.com/charts/bcf8ebc8f444112a7fde85273a41447e.png" />

CMG Revenue data by YCharts

Base on this chart, both Texas Roadhouse and BJ's Restaurants look like great investments.  Many companies would kill for the kind of growth they've had.  But Chipotle Mexican Grill and Buffalo Wild Wings still run away with this metric.  Chipotle's growth (which happens to be debt-free) is great, and is still fantastic when compared to its peers.  

Value or Overvalued?

This is a hard question to answer.  My dad always told me as a kid, "a good price for something is what someone is willing to pay."  I think that applies here...sort of.  The opinions vary greatly, but there are some objectives we can consider.  Bears don't like the P/E ratio over 30, and neither do I.  The near-300% stock price gain for 2010-2011 is also a red flag.  However, I find it interesting that one bear gave Chipotle a fair value of $306/share.

The bulls basically just keep saying that it is a solid company.  And it is.  As we’ve already seen, the company is exploding with new growth.  One bull gave Chipotle a fair value of $402/share.

Undervalued or overvalued?  I'm really not sure, and I see good points on both sides of the argument.  The stock is pricey, but the business is one of the biggest growth stories of this decade.  You could probably find a cheaper stock, but you'd likely be buying a cheaper business.

The Problems at the Grill 

To be clear, David Einhorn isn't recommending the short sell because he sees Chipotle as overvalued.  The recommendation is specifically because of some economic pressures the company is/will be facing.  And it's true, Chipotle is facing challenges.  Some of these include:

  1. Taco Bell
  2. Rising Food Costs
  3. Legal Problems

Let's start with the bottom of the list and work our way up like David Letterman.  

Legal Problems

Legal problems are normally on a company's radar when it comes to risk assessment.  But legal issues aren't just on Chipotle's radar, they are in Chipotle's living room staring them in the face.  The company has several ongoing class action lawsuits stemming from the drop in Chipotle's stock price.  It's not good news, but what can you do?  We live in a world where anyone can sue anyone for anything.  What has me more concerned than the stock price suits is the legal problem Chipotle has with the hiring of undocumented workers.  That may seem like old news because it happened a couple of years ago, but it’s an ongoing case.  The government is probing for criminal activity on Chipotle's part, and even the SEC is flexing their muscles on the issue right now.

Rising Food Costs

In another article of mine, I discussed how the record drought in the US is already affecting food prices, leaving some businesses vulnerable.  The article was in specific reference to Buffalo Wild Wings, but it could apply to any restaurant that doesn't have food contracts in place to buffer them from food price surges.  I’m not sure what the end result will be, but no doubt rising food costs will cut into profits.

Taco Bell

And finally, the moment you've all been waiting for: Chipotle Mexican Grill could suffer from increased competition from YUM! Brands (NYSE: YUM) Taco Bell.  We've heard this before, but this was a big motivator behind Einhorn's recommendation.  I found this article on the Taco Bell issue.  It's really thorough and shows how much Taco Bell could potentially cut into Chipotle's profits.

But Chipotle is keeping its cool through all this.  They said "We have a different customer base and very loyal customers. What’s more, the food we serve is very different than Taco Bell."  Many customers would also agree with that statement.  Could Taco Bell destroy its profits?  Yes, of course they could.  But I, like Chipotle management, am inclined to think it won't be as bad as some would have you believe.


When all is said and done, you can't deny that Chipotle is a well run business.  It continues to open new stores and crank out profits.  I don't think selling short is a gamble that will pay off.  I'm not saying the problems aren't real—they are.  Clearly the sea is a little choppy.  But to continue the analogy, who is better suited for high seas?  A 10 foot kayak, or an aircraft carrier?  Chipotle is healthy; so healthy that it can weather the storms that come its way.  The company isn’t invincible, I know.  Even the "unsinkable" Titanic met her match on her maiden voyage.  But these risks must be kept in perspective.  Assess the risk in conjunction with Chipotle's strengths.

thequast has no positions in the stocks mentioned above. The Motley Fool owns shares of BJ's Restaurants, Buffalo Wild Wings, and Chipotle Mexican Grill. Motley Fool newsletter services recommend Buffalo Wild Wings and Chipotle Mexican Grill. 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.

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