Chipotle Mexican Grill (NYSE:CMG) is a favorite of mine when it comes to lunch options. But CMG also is a favorite of mine when it comes to talking about stocks that are ready to flop. This company simply can’t keep up its breakneck growth — and when you look at the performance of other restaurant stocks, it is overdue to hit that inevitable wall that comes when a fad chain overextends itself.
Chipotle assuredly is a hot dish, but expect this stock to cool to room temperature very soon. Here’s why:
The Ghosts of Restaurant Stocks Past: Wall Street is littered with the wreckage of hot restaurants that grow and expand, delivering a quick double or triple to shareholders, only to watch the bottom fall out. Consider Krispy Kreme (NYSE:KKD) — from around $10 after its IPO in 2000 to almost $50 in 2003. It seemed like the cult donut shop would never come down. But by the end of 2004, it was again approaching $10 and is now around $7 a share. InvestorPlace.com contributor Lawrence Meyers does a great job showing these flops visually with charts of Cheesecake Factory (NASDAQ:CAKE) and P.F. Chang’s China Bistro (NASDAQ:PFCB) in his own bearish take on CMG. The fact is you can only build so many stores so quickly to prop up growth. Eventually the market becomes saturated or the rate of expansion is no longer large enough to materially impact earnings and sales growth.
Inflation Squeezing Margins: On the margins front, almost every ingredient the company uses is suffering from rampant inflation. Chipotle announced this summer it will be hiking prices to offset this trend — its first increase in menu prices since the recession — but it remains to be seen if that will be enough. Food prices comprise more than one-third of overall costs, meaning this is perhaps the biggest bottom-line issue for the company.
Shares Outrunning Earnings: I’ll admit Chipotle’s revenues are impressive, up 21% in the past year to $2 billion. Its net income is up at an ever faster clip, climbing 41% to $192 million. However, the company has a nosebleed forward PE ratio of 39 — compared with peers in the restaurant biz, that’s ridiculous. McDonald’s (NYSE:MCD) is around 16. Yum! Brands (NYSE:YUM) is 17. Wendy’s (NYSE:WEN) is 22. Faster-growth franchises also are dramatically lower — Dine Equity (NYSE:DIN), which has seen five-year growth of 187% in its locations, has a PE of less than 12. The PEG ratios of all these other chains are also significantly less than Chipotle as well, proving even with growth priced in (presuming those growth estimates stick), shares might be overvalued.
No Adaptation to Consumer Health and Spending Trends: A 900-calorie burrito is hardly health food, and an $8 lunch is hardly a bargain given value menus at competitors. Chipotle has a handful of healthier options (hold the sour cream) and slightly more affordable fare, but without any menu innovations, the stock is playing itself into a tight corner. McDonald’s has managed to find new avenues for growth through breakfast, premium coffee and more. CMG still is a one-trick pony.
Click to EnlargeAre Recent Flops Signs of Things to Come? In August, Chipotle stock went from about $320 per share to $270 in just seven days as the market melted down — almost 15%. About a month ago, shares went from $330 on Sept. 29 to around $290 — about 12% down. Each time you can see that CMG bounced back strongly — and yes, the 50-day and 200-day moving averages continue to climb ever higher. But it’s worth noting that since July, Chipotle has been very volatile but has failed to sustain any new highs and break through as it has so many times in the past few years. Optimistic CMG investors should at the very least consider this an indication there will be another 10% dip to buy in lower than current prices. And those who are bearish on the stock have a good case to insist Chipotle will continue to have trouble moving up significantly from here.
Jeff Reeves is the editor of InvestorPlace.com. Write him at firstname.lastname@example.org, follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook. As of this writing, he did not own a position in any of the aforementioned stocks.