For the longest time, I was bearish on Chipotle Mexican Grill, Inc. (NYSE:CMG) stock. The company couldn’t seem to shake food safety issues that hurt Chipotle stock. Meanwhile, health-related food trends passed the restaurant chain by. Poke and superfood bowls emerged to the forefront.
Chipotle burritos took a backseat. Consequently, the recovery moved along at a snail’s pace because consumers left Chipotle after food-safety issues and never came back because they fell in love with poke. Net result: Chipotle stock kept dropping.
But things are starting to change for CMG stock.
It was inevitable that if Chipotle stock kept dropping, there would be a price to buy the stock. A little over a month ago, I said that price was below $270.
Since then, CMG stock dropped below that $270, the company got a new CEO, and the stock rebounded with serious velocity. In a matter of days, Chipotle stock rose nearly 30% from $250 to $320.
Chipotle stock has been stuck in neutral around $320 since late February. But this rebound isn’t over. The new CEO, the same guy who turned Taco Bell around, brings with him a fresh outlook on an increasingly dated brand. As such, the outlook for growth over the next several years is now better than ever before.
I realistically see upside for Chipotle stock to above $360. Here’s how I get there.
New CEO, New Opportunity
Chipotle has fallen into the basket of yesterday’s favorite brands.
The health-oriented consumer has fallen in love with poke and acai bowls, while the fast casual Mexican food lover has been drawn in by Taco Bell’s marketing and menu innovations. This double headwind is largely why the Chipotle recovery has moved along at a snail’s pace.
But there is new opportunity with a new CEO at the helm. Especially considering that the new CEO (Brian Niccol, the former CEO at Taco Bell) is the guy who led Taco Bell’s recovery from struggling fast casual brand to millennial hot spot.
Under Niccol, Taco Bell leveraged targeted advertising and trendy menu additions (like Nacho Fries) to turn into one of the more successful fast casual brands in the industry. For the past several years, comparable sales growth at Taco Bell has run in the low to mid single digit range.
Niccol will do the same thing at CMG.
Chipotle’s image and menu will get much needed makeovers. There will be a ton advertising targeted specifically at the millennial crowd. The menu will expand to include trendier, more fun options. All together, Niccol should be able to drive better results going forward for CMG.
Before, I thought this Chipotle stock recovery would comprise a low single digit rise in comps over the next five years. But Niccol managed to grow comps at a low to mid single digit rate at Taco Bell. Consequently, given fairly easy laps at CMG, I think Niccol and CMG can grow comparable sales at a mid single digit rate over the next five years.
Including unit growth, that should translate into 5-10% revenue growth per year over the next 5 years. At the midpoint, that would put 2022 revenues at $6.4 billion.
Higher comparable sales growth means higher average unit performance, which should translate into higher margins. Operating margins are currently at 6%, but were 17% at their highs in 2014-15. Wage pressures will keep margins from ever getting back to their 17% highs, but a 15% target in 5 years seems reasonable.
On $6.4 billion in revenues, a 15% operating margin implies operating profits of $960 million in 5 years. Taking out 21% for taxes and dividing by 28 million diluted shares, you get to roughly $27 in earnings per share in 5 years.
From last year’s $6.17 base, that would imply roughly 34% earnings growth per year over the next 5 years. A sustainable long-term average price-to-earnings/growth (PEG) ratio for stocks is roughly 1.25, according to Yardeni Research.
Applying that 1.25 PEG to a 34% earnings growth company, you get to fair forward earnings multiple of 42.5. A 42.5-times multiple on 2018 earnings estimates of $8.50 implies a fair value of just over $360.
Bottom Line on Chipotle Stock
The turnaround has started. And its not over yet.
Chipotle stock was beaten up so much that it was due for a rebound. The new CEO promises new opportunity, and that new opportunity adds firepower to this rebound.
As of this writing, Luke Lango was long CMG.
