I’ve been bearish on struggling fast-casual chain Chipotle Mexican Grill, Inc. (NYSE:CMG) stock during its entire descent from $700 to $300.
The thesis was pretty simple: The more the company had to focus on putting out health-related fires, the less time they had to adapt to the ever-changing needs of health-conscious consumers. Consequently, the health trend passed them by. Consumers moved onto poke bowls and acai bowls, and CMG stock got killed.
But I also believe there is value to the brand. Recently, I pegged that value at $275 per share. So I said buy Chipotle stock as it falls below $270 and approaches $250.
Chipotle stock did test that $250 level. And then the company announced that they are tapping Taco Bell’s CEO Brian Niccol to run their business. As a result, CMG popped.
Now, CMG hovers around $290. Although that is above my original $275 fair value, I think this is the perfect time to buy CMG stock.
Why? Because Niccol is the perfect man for the job. With him at the helm, the CMG recovery could gain some serious momentum rather quickly. And Chipotle shares could be worth a lot more in the future than its worth today.
Change Is In the Air at Chipotle Mexican Grill
By most measures, Taco Bell is what Chipotle wants to be.
Thanks in large part to the efforts of Niccol, Taco Bell has transformed from just another unhealthy ffast-casualrestaurant to a trendy dining option. The key to this transformation was Taco Bell appealing to its biggest customer base — millennials.
Taco Bell did this by rolling out a strong marketing campaign (see this ad) and creating a dynamic and trendy menu (Taco Bell is always adding items to its menu, and the additions are usually bold and flavorful, like Nacho Fries).
The combination of those two things led to Millennials flocking to Taco Bell en masse. Because Millennials spend a whole bunch of money on eating out, attracting that demographic provided a huge sales lift to Taco Bell, and comparable sales growth has been red-hot for the past several quarters.
A similar transition could play out at Chipotle.
Granted, the business model is different (Chipotle has company-owned locations while Taco Bell is largely franchised). And the scale is different (Taco Bell’s ad budget dwarfs Chipotle’s ad budget). But its the same industry with the same customers and the same dynamics.
Niccol will likely double down on Chipotle’s marketing, pushing out trend-focused ads that appeal to young consumers. These ads will make consumers think about Chipotle in a whole new way. That’s a good thing, considering the Chipotle image is still clouded by health related issues. A coordinated and strategic marketing campaign is exactly what CMG needs to re-brand itself and make itself cool again.
Niccol will likely also add some innovation to Chipotle’s rather simple menu. Again, this will force consumers to think about Chipotle in an entirely new way, and that isn’t a bad thing.
All together, change is finally coming to CMG. That is a good thing. CMG has an opportunity to fully re-brand itself and come back into the fast casual spotlight for something other than a health-related issue.
What does that mean for the valuation of CMG stock? It goes up. Comparable sales growth at Taco Bell has hovered in the mid single-digit range. I think Niccol can do the same for CMG, considering the laps are pretty easy. Roughly 5% comps plus unit growth should drive something like 7.5% sales growth (not 5% as I previously forecast). A 7.5% top-line growth rate over the next 5 years puts 2022 revenues at $6.4 billion.
I maintain my margin outlook for 12.5% operating margins, so operating profits will look like $800 million. After a 21% tax rate and on roughly 28 million shares out, that equates to around $22.70 in earnings per share
At that point in time, earnings growth will likely be in the high single-digit range (low single-digit comps with some unit growth, but not much margin expansion). McDonald’s Corporation (NYSE:MCD) is currently trading at 22-times forward earnings for long-term earnings growth of 8.5%. Therefore, a 22 forward multiple for CMG in 2021 feels appropriate.
A 22-times forward multiple on $22.70 implies a year-end 2021 price target of just under $500. Discounting that back by 10% per year, you get to a present value of $340.
Bottom Line on Chipotle Stock
I think CMG stock is materially undervalued now, but besides that, the sentiment just feels right to buy CMG stock at this point in time.
The stock just had its best day in four and half years. There is finally a new CEO at the helm, and he is coming off an extremely successful run at Taco Bell. In other words, change is in the air. And change is exactly what this struggling chain needs.
As of this writing, Luke Lango was long CMG and MCD.