This Is Why You Don’t Pay a Premium for Chipotle Stock

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CMG stock - This Is Why You Don’t Pay a Premium for Chipotle Stock

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Just when it looked like Chipotle (NYSE:CMG) was out of the woods, the company is stung by yet another health issue.

Business Insider recently reported that Chipotle had closed a restaurant in Ohio on Monday following reports of customers getting sick after eating there over the weekend. CMG stock dropped 6% in response to the news. The stock is now trading well below where it was before its big earnings pop last week.

Bulls will say this selloff in CMG stock is an overreaction. The reports were made via an anonymous reporting site (iwaspoisoned.com), and on that site, numerous reports are made every week at various fast food locations. Thus, bulls will argue that Chipotle isn’t alone in this issue. They will also say that one store closing is meaningless in the big picture.

Bears, meanwhile, are saying “told ya so!” The reporting site is anonymous, and reports are made all the time. But, locations aren’t getting shut down all the time, and Chipotle shutting down a location is a fairly serious measure. Plus, bears will argue that Chipotle has been battling food safety concerns for a long time now. Thus, any health-related issue brings up a whole swarm of bad memories, the sum of which could stall the comeback story.

Who is right when it comes to CMG stock? Bulls or bears?

I think the bears are right. Here’s a deeper look:

Health Issues Underscore Weakness In the Growth Narrative

Here’s the thing about CMG stock. The company reported strong second-quarter numbers, which underscored that this company’s operational comeback through increased marketing, delivery and menu innovations is progressing nicely. Investors got excited and pushed the stock up to $480.

But, at $480, CMG stock was woefully overvalued. The forward earnings multiple on the stock had jumped to above 50. By comparison, Facebook (NASDAQ:FB) trades at 24X forward earnings. Google (NASDAQ:GOOG) trades at 27X forward earnings. Nvidia (NASDAQ:NVDA) trades at 31X forward earnings. McDonald’s (NYSE:MCD) trades at 20X forward earnings.

In other words, not only was CMG stock trading at more than double the valuation of MCD, but it was also trading at a huge premium to secular growth giants with 20% to 70% revenue growth. For what its worth, Chipotle’s revenue growth last quarter was 8%.

In the big picture, at $480, the valuation of CMG stock made no sense. Thus, the stock was susceptible to a huge pullback on any operational hiccups.

We got that hiccup. CMG stock dropped sharply. That is pretty sensible.

Worse yet, this could actually prove to be much more than just a hiccup. Chipotle can’t seem to shake food safety concerns. If a fast food chain can’t shake food safety concerns in an era where every other fast food chain is getting “healthier,” then that fast food chain could struggle with traffic so long as those food safety concerns persist.

The Ohio restaurant closing shows that these concerns are still around today. Thus, paying a premium for CMG stock here and now makes no sense.

Chipotle Stock Is Fairly Valued Around $415

What should you pay for CMG stock today? I wouldn’t pay much more than $415.

Revenue growth is currently sub-10% in a bounce-back year when revenue growth is supposed to bigger than normal. That implies that sub-10% revenue growth is here to stay for the foreseeable future. But, thanks mostly to delivery-related and menu innovation tailwinds, I think Chipotle can grow sales by around 8%-9% per year over the next five years.

During that stretch, I also think that margins can rebound to 15%, significantly above today’s level but below peak-2015 levels due to higher delivery sales. Under those assumptions, I think CMG can do about $29 in earnings per share in five years. A growth-average and McDonald’s-like 20X forward multiple on that implies a four-year forward price target of $580. Discounted back by 10% per year, that equates to a present-day value for CMG stock of roughly $415.

But, the above modeling assumes mitigated impact from health issues.

If these health issues persist, and Chipotle finds itself closing more than one restaurant per year due to illnesses, then the above modeling goes out the window. In that scenario, traffic growth will take a hit, revenue growth will likely run around 5%, and margins will have a tough time tracking higher without big revenue growth.

Thus, all together, I think CMG stock is worth, at best, $415 today.

Bottom Line on CMG Stock

Like many other stocks in the market, CMG stock got ahead of itself in July. The stock is now reasonably pulling back on bad news. This pullback could persist, and I reasonably don’t see any reason to own this name until it drops to the lower $400s.

As of this writing, Luke Lango was long FB, GOOG and MCD.


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