Enormous volatility in shares of Mexican fast casual eatery Chipotle (NYSE:CMG) has created tremendous buying and selling opportunities in Chipotle stock over the past year.
It fell all the way back nearly $400 by October. That was another buying opportunity. It rallied back to nearly $500 in December. Time to sell again. Then, it dropped to below $400, which was yet another opportunity to buy.
Now, CMG has again rallied to above $500. This big rally above $500 will end no differently than prior similar rallies. It will inevitably fade. Quite simply, the fundamentals don’t support a $500 price tag for Chipotle stock just yet, while the technicals indicate that the stock is overbought in the near term and due for a pullback.
In other words, this is another opportunity to sell the rally in Chipotle stock. Eventaully, CMG will rally above $500 and hold that level. But, not today. Today, this stock should ultimately fall back into the $400’s relatively soon.
Chipotle Has Healthy Drivers
When it comes to the qualitative growth narrative underlying Chipotle stock, you have some good and some bad.
On the good side, Chipotle’s comparable sales growth trajectory is turning around and margins are finally rebounding. This is due to multiple company-specific initiatives that have reinvigorated growth. Namely, the company is aggressively expanding its presence in the digital food ordering and delivery market, which is a red hot market that is still growing by leaps and bounds.
Also, Chipotle is innovating on its menu for the first time in a long time. In so doing, the company is bringing in new customers through new items like diet lifestyle bowls.
Alongside these new innovations, the Chipotle brand has also finally developed a voice for itself through a unique “Get Real” marketing campaign that emphasizes the authenticity and uniqueness of Chipotle’s food ingredients and preparation.
All of these developments are positive for Chipotle stock. They should drive continued positive comparable sales growth and margin expansion for the foreseeable future, and keep Chipotle relevant in the crowded quick service restaurant space.
There Are Big Risks, Too
On the bad side, the crowded quick service restaurant(QSR) space is only getting more crowded.
McDonald’s (NYSE:MCD), long known for producing what the public perceived as “cheap” food, is stepping up its game on the health front by rolling out fresh beef patties and eliminating antibiotics from its global supply chain.
Movements like these, which are happening everywhere and not just at McDonald’s, somewhat erode Chipotle’s moat as a unique fresh food QSR.
Also, the poke and acai bowl trends remain the fad in the healthy QSR space , meaning that Chipotle’s burritos continue to lose share among health-oriented consumers. Wage pressures are also picking up, with inflation and wage growth hitting multi-year highs, and that’s a major headwind for margins.
It’s also worth mentioning that Amazon (NASDAQ:AMZN) is making a big push in the QSR and convenience store space with cashier-less convenience stores, and that is a potential long term threat for Chipotle.
Overall, the Chipotle narrative has some good, and some bad. Above $500, Chipotle stock reflects just the good, and that makes the stock unnecessarily risky.
Chipotle Stock Isn’t Supported Above $500
When it comes to the fundamentals underlying CMG, they are, much like the narrative, a mixed bag.
Comparable sales growth trends are improving and running in the positive mid-single-digit range. But, all of that growth is from price hikes, not traffic growth. That isn’t sustainable.
Eventually, price hikes will run their course. Once they do, comparable sales growth will normalize lower. They will likely settle in the low-single-digit range. LSD comps plus some unit expansion should drive ~7.5% revenue growth per year over the next several years.
Margins are trending higher. This will continue because they are rebounding from a depressed base. But, restaurant level margins are up only 170 basis points year-to-date to 19.3%.
I say “only” because, at their peak, RLMs were above 27%. Chipotle won’t get back to those RLMs. Average unit volumes likely won’t eclipse their previous peak, and even if they do, it will be because of price hikes and not traffic. If prices are going up, that usually means wages and other costs are going up, too. Thus, it’s net neutral on the margin line.
Going forward, Chipotle is a company characterized by sub-10% revenue growth and mild margin expansion. In combination, that should realistically drive earnings per share to $30 by 2023. A restaurant average 22 forward multiple on that implies a fiscal 2022 price target of $660. Discounted back by 10% per year, that equates to a fiscal 2019 price target of just under $500.
Chipotle stock is currently above $500. Thus, the stock is already trading above a reasonable 12 month forward price target. That’s an unfavorable position to be in, fundamentally speaking.
Also, due to the huge rally from below $400 to above $500 in about two weeks, CMG is entering technically overbought territory ahead of earnings. The Relative Strength Index (RSI) on the stock is above 70, or in overbought territory. The stock price is also more than 10% above its 50-day moving average, a large divergence which historically implies a near term peak.
Bottom Line on CMG Stock
Long term, Chipotle stock will be just fine. But, in the near term, this stock is both fundamentally overvalued and technically overbought.
That combination implies a bearish outlook for CMG over the next few weeks, and I wouldn’t be surprised to see this stock fall back into the $400’s relatively soon.
As of this writing, Luke Lango was long AMZN.