Chipotle Mexican Grill: Incredibly Expensive

by The Compound Investor

Chipotle Mexican Grill (CMG) stock has been on one heck of a ride this year. Shares of the California-based restaurant firm bobbed along in the $860 area before the coronavirus reared its head. They then took a nosedive down to the $465 mark, right before rebounding to their present price of around $1,000 apiece. Yes, that’s right, Chipotle stock is actually up circa 16% year-to-date. How may restaurant stocks can say that?

In fairness to the company, it does have a few things going for it. First and foremost, solid historical growth. Ten years ago the company brought in revenue of circa $1,835m from a total of 1,080 restaurants in the United States. Annual profit clocked in at around the $175m mark that year. As of 1Q20, its domestic restaurant count had swelled to 2,595 and trailing-twelve-month revenue worked out to $5,700m. Annual profit came in at $350m last year on an after-tax basis.

Of course, it hasn’t all been plain sailing here. Chipotle was rocked a few years ago after foodborne illnesses were linked to some of its outlets. Suffice to say, that’s not good for a restaurant stock. In fact, it has not yet recovered the same levels of net profit generation that it enjoyed pre-2016. Sales have recovered, but profit margins have taken a hit.

COVID-19

That more or less leads us up to the present situation. One of the other things that Chipotle has going for it is a very clean balance sheet. It reported around $800m in cash & equivalents at the end of 1Q20, with zero debt to boot. It’s refreshing to see a blue chip with a net cash position – doubly so given the current crisis.

For that, Chipotle stockholders can thank the fact that the underlying business throws off a fair amount of cash. I have cumulative surplus cash generation at around $1,000m over the past three years; that’s despite spending a few hundred million dollars expanding the restaurant count. It also spent circa $640m on stock buybacks over that period, leaving $300m or so left over for good measure.

This is clearly a disastrous period for restaurants and fast food outlets. A lot of them will go under. As for Chipotle, we can glean some information from its 1Q20 figures. The company reckoned comparable restaurant sales grew just over 14% through the end of February compared to the same point last year. There was a slight benefit from this being a leap year, but that’s still pretty darn solid. In March, comparable restaurant sales fell 16%. Management reckoned that the comparable sales drop bottomed at 35% toward the end of that month. It also reported that one-hundred restaurants were temporarily shut in the United States.

That’s the COVID-19 impact right there, and at the risk of stating the obvious, this quarter looks set to be very ugly indeed. The good news is that, as per above, Chipotle is in solid financial shape to ride out a significant downturn. It reckoned its cash position was enough to sustain the company for well over a year, should it come to that.

Valuation

COVID-19 aside, I can’t help but think that the big issue here is Chipotle’s current valuation. Its shares just look incredibly expensive to me. As mentioned in the preamble, they currently change hands for around $1,000 apiece. I have trailing-twelve-month earnings at around $13 per share, so call it an earnings multiple of 77x. Yeah, that’s expensive. We are going to need a lot of future growth here.

On that note, the company had forecast mid-single-digit comparable restaurant sales growth this year. It also planned to open around 150 new restaurants at the low-end. Between them, that would have kept the double-digit growth train rolling onwards. That was obviously prior to COVID-19, and we should probably write this year off.

Looking a bit further ahead, analysts expect Chipotle to make circa $20 per share in FY21. I’m not sure how many of those estimates pre-date COVID-19, but it doesn’t matter too much. I mean, Chipotle needs to earn circa $40 per share in net income just to a reach an earnings yield of 4%. That’s based on the current share price too, never mind factoring in some extra investment returns on top. Maybe it gets there in a few years if we are being generous, but it looks likes that’s already priced in. Overall, I see very little margin of safety with Chipotle stock right now.

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