I am a big fan of Chipotle Mexican Grill’s (NYSE:CMG) food, but not of its stock. Like many concept restaurant chains, it is wildly overpriced, and will eventually come back to earth.
The question is whether Chipotle will remain successful like Cheesecake Factory (NASDAQ:CAKE) or go the way of now-struggling Ruby Tuesday (NYSE:RT).
Ruby Tuesday has had an interesting history, gone through different expansion concepts and struggled to maintain its brand identity. The trick with concept restaurants is that they either become a fad or a favorite. Ruby Tuesday apparently is dealing with an image as the former, and its stock chart — as well as the announced closure of 27 struggling stores — reflects this.
The problem with some chain restaurants is that they overexpand and saturate the citizenry with its food. There is some wisdom in the idea of more modest expansion, like Cheesecake Factory has engaged in. You’d rather have people waiting for a table who really want one than people who have burnt out on your food.
Ruby Tuesday has only $8 million in cash and almost $300 million in debt. The reason it’s still afloat is that it generated high eight figures in free cash flow. So it isn’t going bankrupt, and seems to be growing at about 13% annually and is priced appropriately. Bottom line: The concept has outgrown its momentum phase. The question going forward is whether it will be able to continue to grow.
So is Chipotle headed for the same fate? It’s impossible to predict the future, but I think it is.
Chipotle has good food, but it ultimately isn’t all that different from other selections, and it’s the kind of food that people get burnt out on. It does not offer some groundbreaking new taste, or new way of eating, or new food. That is certainly not to say that the stock can’t go higher. It is a momentum play, and nobody gets in the way of the momentum train unless they want to get flattened. But the stock is trading at almost 60 times earnings against expected long-term growth of 20%.
At some point, that multiple is going to contract. Chipotle still will be doing well, but that multiple is going to fall. That suggests there will be a time to short the stock, and that time will be when free cash flow starts to fall, when revenue and earnings miss for more than one quarter, and if management starts closing stores.
Until then, however, stay off the railroad tracks.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Capital, Inc., which brokers secure high-yield investments to the general public and private equity. You can read his stock market commentary at SeekingAlpha.com. He also has written two books and blogs about public policy, journalistic integrity, popular culture and world affairs.