Shorting Chipotle Because of Taco Bell Not Hot

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Chipotle Mexican Grill (NYSE: CMG) has seen its stock fall in the days following a hedge fund manager saying that he thought people would prefer Taco Bell food rather than the offerings from Chipotle. I immediately thought, “This must be one of those inside jokes that are too often lost upon me.”

But this was no joke. The comment was made by prominent hedge fund manager David Einhorn at the Value Investing Congress this week. As he’s well-respected and revered, investors took Einhorn’s strategy to short Chipotle to heart. The stock was trading around $317 when the markets opened Tuesday, before Einhorn started speaking. It fell to $295.61 by noon. At the time of this writing, it still had not recovered the losses.

Einhorn’s concerns about the future of Chipotle stemmed from his belief that Taco Bell, which is owned by Yum! Brands (NYSE: YUM), will give Chipotle a run for its money. As president of Greenlight Capital, Einhorn said his company conducted a survey that showed Chipotle was in danger of losing frequent customers to Taco Bell.

Specifically, Einhorn seems quite enamored by Taco Bell’s new Cantina Fresh Mex menu. Touted as a creation of a top chef, and a bargain for people seeking higher quality at the fast food restaurant, the menu is impressive. However, unlike Einhorn, I stop short of saying that it compares to Chipotle’s items. In fact, it pales in comparison.

I think Damon Vickers, chief investment officer for Damon Vickers & Co., said it best this week when he pointed out that the Cantina items Einhorn is excited about come off of the same assembly line as its burrito, and they are made with ingredients arriving from a corporate food truck. Chipotle’s ingredients are locally sourced, allowing them to offer fresher ingredients.

My personal food preferences aside, I think most diners wouldn’t put Chipotle and Taco Bell in the same group. Taco Bell’s new, higher priced items may help it improve its margins, but I don’t think they’ll lure people from Chipotle in the droves that would affect Chipotle’s fundamentals and make it less of a worthy stock investment.

If I chose to short Chipotle, it wouldn’t be because its profits could be threatened by Taco Bell. If nothing else, the comparison between Taco Bell and Chipotle screams of the old adage, “comparing apples to oranges.”

Einhorn did point out some things I think investors should consider because they represent the more realistic pressures that Chipotle faces. For example, he noted rising food costs, which is noteworthy since Chipotle thrives on using fresh ingredients. At least Chipotle enjoys serving customers who I don’t believe would mind paying a little more for their food.

Also, Einhorn talked about Chipotle being mandated to offer health insurance in the future thanks to Obamacare. Also worrisome are allegations that the company is using undocumented workers, which can raise the ire of the federal government.

These are issues that could place pressure on Chipotle’s margins, which have been strengthening. Chipotle’s profit margin has increased since 2008, rising to 11.82% from 7.18%. Net profit on sales increased to 10.5% last year from 6.7% in 2008. Also, its earnings per share has improved, rising to $8.72 from $6.66 over the past five quarters. Some estimates show that Chipotle’s operating margin should rise to 17.4% in 2012 from 15.4% in 2011.

Chipotle reports third quarter earnings on Oct. 18, and if all goes well, maybe its stock will return to pre-Einhorn talk levels.

 


TwillyD has no positions in the stocks mentioned above. The Motley Fool owns shares of Chipotle Mexican Grill. Motley Fool newsletter services recommend 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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