Shares of fast-casual Mexican eatery Chipotle (NYSE:CMG) have been on fire in 2019, rising almost 100% through the first 10 months of the year to new all-time highs. Behind the rally? A few blockbuster earnings reports, which when strung together, show that this company has fully recovered from its 2016 E. coli scandal and is back to firing on all cylinders.
This big CMG stock rally will be tested on Tuesday, Oct. 22, when the company reports third-quarter numbers. Will the numbers be good? Will the stock rally?
In short, the numbers should be good. Multiple data points suggest that continued menu innovations at Chipotle have been providing strong traffic tailwinds, and Q3 numbers should reflect this. But, CMG stock appears fully priced for good numbers, so shares may not rally in response to the strong print.
The investment implication? Be careful. The Chipotle business is on fire, but CMG stock is richly valued. That’s a tricky combination which requires operational perfection to work — and perfection is hard to sustain.
Chipotle Earnings Should Be Good
Chipotle’s third-quarter earnings report should be very good, headlined by strong traffic numbers and improving margins.
On the strong traffic front, multiple data points suggest that continued menu innovations have been providing strong traffic tailwinds for the quick-service restaurant operator. First, the company stayed on the course of menu innovations this past quarter, going national with carne asada meat and running multiple relevant promotions related to their broader vegan push. This strategy has worked over the past year, and likely continued to work over the past few months.
Second, BTIG recently put out a note saying that their data shows that these menu innovations provided strong traffic tailwinds in the quarter. Third, data from Placer.ai — a leading foot traffic analytics platform — shows that Chipotle’s huge foot traffic gains through the first half of 2019 remained large over the past few months. Fourth, restaurant sales have broadly remained on a healthy uptrend, posting a nice 3.7% year-over-year gain over the past three months.
Strung together, these four data points paint a favorable picture of Chipotle’s operations over the past few months, and imply that Chipotle’s Q3 numbers will be quite good.
Chipotle Stock Is Fully Valued
Unfortunately for bulls, good numbers may not be good enough to spark a rally in CMG stock.
Why not? Chipotle stock’s valuation.
Chipotle stock is just about the most richly valued restaurant stock out there, at over 60-times forward earnings, when the rest of the restaurant sector is trading at roughly 26 times forward earnings. Sure, there’s some growth support for the valuation. That support includes persistently big comparable sales growth, a long runway for unit growth and margins that are tracking higher.
But, there’s not “60-times-forward-earnings” support here.
For the foreseeable future, you are talking mid to high single-digit unit growth, low to mid single-digit comps and a few hundred basis points of margin expansion. That creates visible runway for 20% earnings per share growth going forward. That’s good. But not good enough to warrant a 67 times forward multiple.
Indeed, the rest of the restaurant category is expected to grow profits at more than half of that rate over the next few years (roughly 11% EPS growth, versus 20% for CMG), but that category trades at less than half the valuation (26 times forward earnings, versus 67 times for CMG).
As such, ahead of the Q3 print and on the heels of doubling year-to-date, CMG stock looks fully valued.
Bottom Line on CMG Stock
Chipotle is on fire. There’s no arguing that. Third-quarter numbers should confirm this reality.
But, CMG stock is also fully priced for this reality. That is, the stock already trades at levels which fully incorporate big growth for a lot longer.
The investment implication ahead of earnings? Be cautious. CMG stock needs perfection to keep marching higher, and perfection is hard to sustain.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.