Once the most hated restaurant stock in the market, Chipotle (NYSE:CMG) has staged a huge comeback over the past several months. Since bottoming in mid-February around $250, Chipolte stock has more than doubled over the past six months, and now trades north of $500.
I was bullish on this comeback when Chipolte stock was down around $250. At those levels, the company’s long-term growth prospects through unit growth and reinvigorated foot traffic were being undervalued by the market.
But, with Chipolte now trading above $500, I think this rebound has come too far, too fast, and that buyers here are ignoring huge fundamental risks to the business. Namely, the restaurant still has lingering health issues that just don’t seem to go away, and the health food craze has simply passed up Chipotle burritos.
Now, all the buzz in the healthy food world is about super-food and poke bowls. Chipotle burritos are quickly heading the way of Subway sandwiches.
Despite these risks, Chipolte now trades at 60X forward earnings. That multiple is simply too big, and represents unrealistic expectations regarding future growth prospects.
As such, I think Chipolte stock is maxed out here and now, and wouldn’t be surprised to see this stock drop below $500 soon.
Chipotle Stock Has a Weak Narrative
At its core, the narrative supporting Chipolte isn’t all that great.
Yes, I understand that the company has a tremendous unit growth narrative ahead of it. Yes, I understand that the new CEO executed a massive turnaround at Taco Bell and will likely do the same here.
I also understand that new menu innovations like bacon and nachos will continue to improve traffic trends. And, yes, I understand that the consumer is about as strong as ever right now and that naturally, Chipotle will benefit from that.
But, in the bigger picture, Chipotle faces two major headwinds which keep this narrative from being that attractive.
First, the restaurant is still getting people sick. I’m not sure what it is about Chipotle, but this company can’t seem to shake health related issues. The latest food-borne illness caused 700 Chipotle customers in Ohio to fall ill due to food that had been left at unsafe temperatures.
News of this outbreak will surely dampen traffic trends across the country, and until Chipotle goes without a health-related issue for at least twelve months, it is tough to see consumers really trusting the restaurant to not get them sick.
Second, traffic is still negative. That’s somewhat shocking in context of the stock’s 100% rally. Restaurant transactions were down nearly 2% last quarter, and down the quarter before that, too. That means less and less people are eating at Chipotle.
Without traffic growth, it is tough to see Chipotle really growing by all that much over the next several years. The fundamentals don’t imply a rebound here, either.
The reality of the situation is that health-conscious consumers have moved onto to acai and poke bowls, while price-conscious consumers have moved onto to McDonald’s (NYSE:MCD), a company which has done a great job refreshing their menu to be healthier.
Who is Chipotle left with? The Chipotle faithful; they are surely loyal to Chipolte. But, that base isn’t growing by all that much, and indeed may be shrinking (transaction growth is still negative).
Overall, despite the big rebound in Chipolte stock, the narrative supporting Chipotle is actually more bad than it is good.
Chipotle Stock Needs to Cool Off
Against a troubled growth narrative, Chipolte looks way overextended above $500.
Chipolte trades at 60X forward earnings. That is a multiple reserved for high-growth technology players with robust revenue growth and margin expansion potential.
But, Chipotle has neither of those. Revenue growth is running below 10%. Margins are increasing, but by less than a 100 basis points on a depressed lap. Going forward, margins will be pressured by persistently rising labor expenses, and further expansion is far from a sure thing.
Thus, Chipotle is a company with mild revenue growth potential and limited margin expansion potential. Stocks with those fundamentals don’t trade at 60X forward multiples.
Bottom Line on Chipolte Stock
Chipotle’s stock price has sprinted way ahead of fundamentals. Core problems remain, and the current valuation does not appropriately reflect these risks. As such, over the next several quarters, I wouldn’t be surprised to see Chipolte drop below $500 and trade largely sideways.
Having said that, I also don’t think Chipolte will drop in a big way, either. The consumer and economy are simply too strong right now to cause Chipotle’s numbers to fall out.
Without those numbers falling out, Chipolte won’t drop like a rock. Instead, this is a stock that will be stuck in neutral.
As of this writing, Luke Lango was long MCD.
