It Feels Like It’s Time to Short Chipotle, But …

by Lawrence Meyers | April 5, 2013 7:54 am

I really wanted to short Chipotle Mexican Grill (NYSE:CMG[1]).

CMG was crazy overpriced. The valuation was ridiculous. It had the hallmarks of stocks I’ve successfully shorted in the past. It was a ten-bagger between 2008 and last April, peaked at $400, and has twice experienced hundred-point drops in the past year. When it hit $250 last autumn, I figured I’d go short when it broke $300.

But a funny thing has happened on the way through $300 to $323. Chipotle’s earnings have caught up with its stock price. It’s still overvalued, but not in the way it used to be.

For a while, its P/E ratio vastly exceeded its growth rate. But now we’re looking at FY13 earnings of $10.25 per share on 20% annualized long-term growth estimates. So you start by putting a 20 P/E on the stock and getting a fair value of $205. It’s got $22 per share in cash, giving it an effective price of $300.

So, from what I can see, Chipotle is still 50% overvalued.

But there are a lot of mitigating factors here. First, CMG is the 16th most-shorted stock on the S&P 500. So there’s a danger a good earnings report could cause a sizable short squeeze later this month, sending the price higher. I never like to be the guy who goes with the pack, especially when shorting.

Second, the Fed’s QE program is continually pushing asset prices higher. Investors are abandoning bonds to move into stocks, and momentum plays have done very well in this environment. Don’t fight the Fed and don’t fight the trend, as the sayings go. You can get burned shorting momentum plays.

Third, the company continues to innovate. Chipotle is adding tofu-centered items to its menu — I can’t stress enough how much of a driver the health trend is[2] — and expanding its new restaurant concepts.

“But,” I think, “CMG is so outrageously overvalued! How can I not short it? Is there some other way to play this beast? Or should I sheath my rifle and hunt other game?”

I certainly could short with a tight stop-loss, but that stop-loss will get blown through if the company reports good earnings. I could wait to see if earnings are great, pushing Chipotle toward its old highs and short it then, since it would be even more overvalued.

Or I could use an options play, which might be the way to go here. I just wrote about call back spreads[3], and the reverse of this might be in order. That is: Sell a put to finance the purchase of two-in-the-money puts right before earnings. If the stock tanks, I win big. If it doesn’t, I have a limited loss.

Stay tuned.

As of this writing, Lawrence Meyers[4] did not hold a position in any of the aforementioned securities. He is president of PDL Capital, Inc.[5], which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books[6] and blogs about public policy, journalistic integrity, popular culture, and world affairs[7]. Contact him at[8] and follow his tweets @ichabodscranium.

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