Shares of fast-casual Mexican eatery Chipotle (NYSE:CMG) has been on fire for the past two years. In 2018, the stock rose about 50%. Year-to-date, shares are up another 93%. In grand total, from the start of 2018 to the end of 2019, Chipotle has risen nearly 200%.
Can the winning continue in 2020?
Yes, but not to the degree that has happened over the past two years. That is, while Chipotle can and will head higher in 2020 behind sustained robust comparable sales and profit growth, further gains will be harder to come by thanks to increasingly large valuation headwinds.
My call for the stock in 2020? It will most likely rise somewhere between 5% and 10%. But, gains closer to 15% and up seem unlikely and/or unsustainable.
Chipotle Can Stay Hot
The dynamic which has propelled Chipotle 200% higher over the past two years is surprisingly simple.
New management — led by former Taco Bell exec Brian Niccol — has leveraged new marketing campaigns, smart promotions, menu innovations and digital business expansion to drive a huge rebound in traffic and comparable sales trends. This huge rebound in traffic and comparable sales trends has powered an equally huge rebound in profit margins, since unit revenues are rising faster than unit costs. Big revenue growth on top of big margin expansion has led to doubly big profit growth, which has converged on a relatively discounted valuation to drive explosive gains in Chipotle stock.
Most of this dynamic will persist in 2020.
Furthermore, management continues to innovate to drive growth. They are doing things like testing a new restaurant design to optimize for delivery and pick-up orders, running promotions, like “Free Delivery Bowl” to drive further digital business expansion. They are also integrating with smart home devices like Alexa to make digital ordering easier for customers, and extending the menu with new items like Carne Asada. All signs indicate that this innovation will persist in 2020. As it does, Chipotle will remain hyper-relevant to the consumer, and this relevancy should sustain big comparable sales growth.
Big comparable sales growth will help drive continued margin expansion. Those two tailwinds will combine to further sustain big profit growth, and that should help drive Chipotle higher.
But, there’s one catch: valuation — and that one catch will limit Chipotle’s upside in 2020.
Chipotle Will Rise… But Not By 50%
Chipotle looks positioned to rise by about 5%-10% in 2020, meaning that while shares can move higher, the days of 50%-plus annual gains are over.
The numbers here are easy to follow. Chipotle this year has been rattling off 5%-plus traffic growth rates and 10%-plus comparable sales growth rates. Of note, the lap isn’t terribly hard — comparable sales rose just 4% in 2018, with traffic growth actually negative. In 2020, the lap will be much harder — double digit comps and 5%-plus traffic growth. At the same time, unit revenue volumes are rapidly closing back in on their pre-E. coli highs.
Naturally, that means that the company’s comparable sales growth rates should normalize lower both next year, and over the next few years. Simultaneously, unit growth rates will also slow because the restaurant remains committed to opening around 150 stores per year; So, the overall store base is getting bigger. Thus, over the next several years, Chipotle will go from a nearly 15% revenue grower, to something more like a 10% revenue grower.
Profit margins will keep moving higher as unit revenues keep tracking higher. Thus, my modeling suggests that margin expansion drivers could turn around 10% revenue growth into nearly 25% earnings per share growth. Under that assumption, Chipotle looks positioned to hit $50 in earnings per share by fiscal 2025.
Based on a restaurant sector average forward earnings multiple of around 25 and a 10% annual discount rate, that equates to a 2020 price target for Chipotle of roughly $850. Growth stocks often trade at a premium to fair value, so upside to $900 seems doable in 2020. But, levels above $900 seem unnecessarily stretched.
Bottom Line on Chipotle
The big Chipotle turnaround will persist in 2020. It will just be less big than what investors saw in 2018 and 2019.
My 2 cents? No need to chase the stock up here. Instead, wait for a pullback, and buy the dip.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
