Chipotle Mexican Grill, Inc. (NYSE:CMG) stock closed near a 52-week high after the company reported much better than expected first-quarter earnings. The earnings beat continues what has been a 20%-plus rally for CMG stock in just over a month. Clearly, the Street is bullish on CMG’s turnaround potential.
But I don’t buy the hype on CMG stock, and here’s why.
Chipotle is adding about 200 new restaurants per year. With a current store base of less than 2,300, there is very little risk to a strong unit growth trajectory. Average restaurant sales are hovering around $1.9 million right now. Before the E. coli outbreak, average restaurant sales were peaking around $2.5 million.
If Chipotle can get average restaurant sales back to $2.5 million within three to five years, it will be on a much larger restaurant base approaching 3,000. Average restaurant sales of $2.5 million across 3,000 restaurants implies a revenue opportunity in three to five years of about $7.5 billion.
If CMG can get revenues to $7.5 billion by 2020, that would be an 18% compounded annual growth rate from 2016. Chipotle’s labor and occupancy costs are only rising in the low double-digit per year range.
Food costs are rising much more quickly, but such high growth should come down in the future. With revenue growth outpacing restaurant operating cost growth, CMG restaurant level margins should expand healthily. It isn’t unfathomable to assume 30% restaurant level margins by 2020 if sales shoot up to $7.5 billion.
A 30% restaurant margin on $7.5 billion in sales less a relatively constant 6% general and administrative expense rate and a 4% depreciation and amortization expense rate leads to about $1.5 billion in operating profit. After a 39% tax rate and with roughly 28 million diluted shares, CMG could net north of $30 in earnings per share. Putting a pre-E. coli outbreak 40x multiple on that, CMG stock could be worth well north of $1,000 per share in about four years.
But that won’t happen.
Why the Bulls Are Wrong on CMG Stock
Too much has changed in the year-and-a-half since Chipotle’s E. coli outbreak, and I doubt Chipotle will rebound fully. Bulls want to point to the 2006 Taco Bell E. coli outbreak as evidence that food brands rebound from big health scandals. I don’t really like that comparison for many reasons.
Firstly, Taco Bell’s comps rebounded much more quickly. Yum! Brands, Inc. (NYSE:YUM) reported that Taco Bell’s comps were -5% in the quarter of outbreak. A year later, they were flat. Overall, that is a two-year stack of -5%.
At Chipotle, though, the two-year comp stack is trending at -12%. That is much worse than Taco Bell.
Secondly, Taco Bell and Chipotle are completely different concepts with vastly different appeal. Taco Bell caters to the price and taste preferred consumer by selling tacos for a few bucks. Chipotle, meanwhile, caters to the health-conscious consumer by selling all-natural burritos. CMG’s motto, after all, is food with integrity.
Naturally, when your motto is food with integrity, a health scare will have a more lingering effect than if you’re Taco Bell.
Slowed sales growth on top of labor inflation and increased competition means CMG will struggle to get earnings to $20 per share in the next three to five years, regardless of unit growth.
If you look at $20 per share as a stretch earnings goal in four years, then you are also looking at 24 times earnings that are four years out. By comparison, tech growth machine Facebook Inc. (NASDAQ:FB) trades at 22 times consensus earnings that are two years out.
No food chain, especially one as beleaguered as Chipotle, deserves that sort of stretched valuation.
Bottom Line on CMG Stock
At the end of the day, when it comes to CMG stock, you have to ask yourself whether or not Chipotle will regain peak-2015 popularity within the next three to five years. If yes, then CMG stock could be well above $1,000 in four years or so. If not, CMG stock returns over the next several years will be greatly limited.
Just like the health trend moved on from Subway’s sandwiches a few years ago, I feel the health trend has now moved on from Chipotle’s burritos. The current trends I am noticing in juice, poke, handmade pasta and wood-fried food adoption are simply too strong to support revitalized mass interest in the “do-it-yourself” burrito.
But CMG stock is acting like the turnaround is well on its way. With the two-year comp still strongly negative, I say CMG still has a ways to go.
As of this writing, Luke Lango was long FB.
