by Lawrence Meyers | November 6, 2013 12:19 pm
Owning or shorting Chipotle (CMG) stock feels like playing roulette — you’re just as likely to win big as you are to lose big. What is an investor to do with this tempting but dangerous stock?
I’ve followed the company for a few years. Up until a few months ago, it always felt overvalued, even after assigning it a healthy premium for having no debt and great cash flow. I gave up on momentum stocks after the dot-com bubble burst in 2000, and have stayed away from them ever since. I’ve been looking for an opportunity to either buy in or short CMG, but it’s too dangerous for either approach.
Back in April, the stock hit $323 off a low of $250. I thought it might be time to short after that bounce, but earnings had caught up to the stock price. FY13 earnings were pegged at $10.25 and had a 20% annualized growth rate, giving it a fair value of $205. I gave it a 20% premium based on cash flow and no debt, lifting fair value to $246. It had $22 per share in cash, so the effective stock price was about $300. Thus, the stock seemed about 20% overvalued. It wasn’t as crazy-insane-overvalued as it had been in the past, however. So I didn’t short.
Now we have a different situation. FY13 earnings are now $10.47, expected to grow 25% in FY14 and 21.4% long term. So now, if I put a very generous 35x estimates on Chipotle stock, fair value is $365. It has $27 per share in cash, giving it an effective trading price of $516. So now the stock is probably 45% overvalued, at the very least.
The problem with shorting here is that Chipotle continues to execute. Its same-store comps came in at 6.2%, with Q4 expected to be the same or better. I also realized that opening a Chipotle store is an easy, low-cost project because the stores follow a stripped-down, minimalist design and has limited menu items that need inventoried.
Free cash flow has been relatively consistent at about $300 million per year. The company has no debt to service, so it can keep plowing money into new stores. To this, I add the “QE Effect” — as quantitative easing continues, more and more money flows into the stock market from the bond market. All manner of stocks have shot past fair value, particularly growth stocks.
I really want to short Chipotle here. The valuation is just crazy. The company trades at a P/E valuation of 40 — almost twice that of its peers. Darden Restaurants (DRI) is at 16, Yum! Brands (YUM) is at 18, Tim Horton’s (THI) is at 19, McDonald’s (MCD) trades at 15, Burger King (BKW) is at 21, and Domino’s (DPZ) is at 24. The other thing about a momentum stock is that is attracts a lot of speculative traders, so it’s difficult to tell who owns the stock for the long haul and who’s just riding the train.
Regardless, you don’t want to step in front of a momentum train. So I’m going to hold off on shorting Chipotle for the moment, but this is where I like to watch the charts and use technical analysis. If the stock breaks some important support going forward, I’ll revisit.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at email@example.com and follow his tweets @ichabodscranium.
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