But the company’s recent financial results have exposed cracks in bull thesis. Here are three holes in the Chipotle story.
Weak same store sales growth
Chipotle Mexican Grill, Inc. (NYSE:CMG)’s recent operating results have been disappointing. Last quarter, the company grinded out a measly 1% increase in comparable same store sales. That’s startling because investors have grown accustomed to double-digit comp growth. Ouch!
So what’s cause this decline?
Yum! Brands, Inc. (NYSE:YUM) is starting to copy Chipotle Mexican Grill, Inc. (NYSE:CMG)’s profitable formula. Last fall the company’s Taco Bell chain introduced its Cantina menu, which features premium burritos with black beans, cilantro rice and marinated chicken or beef for under $5.
Initially Chipotle Mexican Grill, Inc. (NYSE:CMG) bulls didn’t consider Cantina a real threat because of different target demographics, lower product quality, and different geographies. But this assumption is starting to be proven wrong. During the first quarter, Taco Bell reported impressive 6% same store sales growth in the United States.
But my biggest concern: stale menu. With a limited number of menu items could customers be getting tired of Chipotle? This wouldn’t be the first fad in restaurant history.
Margin pressure
Chipotle Mexican Grill, Inc. (NYSE:CMG)’s margins are being hampered by inflation. During the last quarter, management reported higher prices for streak, barbacoa, dairy goods, and salsa ingredients.
Last quarter the company raised menu prices in a attempt to pass on higher raw costs. But the fact that same store sales flat-lined during the same time frame may reveal the company’s fragile moat. Does Chipotle Mexican Grill, Inc. (NYSE:CMG) have the ability to raise prices? Apparently yes, but not without losing customers.
This valuation doesn’t make sense
Single-digit same store sales and margin contraction isn’t necessarily a big problem if Chipotle is trading at a reasonable valuation. But that’s not the case with this stock.
Chipotle is the most expensive in the casual restaurant space trading at nearly 30 times next year’s earnings. With a high-teen earnings growth rate the stock trades at a whopping 1.7 PEG ratio.
What’s puzzling is that I can find so many better stories in the industry that are trading a cheaper valuations.
Take Starbucks Corporation (NASDAQ:SBUX), for example. The company has lots of growth runway in China, Latin America, and India. Starbucks is growing comps at an impressive mid-single digit pace through the introduction of new food and beverages. In addition the company’s margins are expanding with falling coffee prices and greater economies of scale.
Of course, Starbucks isn’t inexpensive at 22 times forward earnings. However, the company is growing earnings at a 20% clip, the same rate as Chipotle. This makes Starbucks’ multiple look downright cheap by comparison.
With Chipotle’s same-store sales growing in the low single digits it starts to resemble Dunkin’ Brands or Panera Bread Co (NASDAQ:PNRA). But both of those stocks can be bought at lower multiples of 21 and 20 times forward earnings, respectively.
Why am I paying a premium for Chipotle exactly?
Foolish bottom line
Despite these concerns I haven’t completely backed away from Chipotle for two reasons. First, the past year’s poor results gives the company easy comps to beat this year. Second, Chipotle Mexican Grill, Inc. (NYSE:CMG) has lots of growth ahead. With less than 1,500 locations, the company has room to double its locations in the North America with international markets remaining almost completely untapped.
But I have to admit, there are a lot of holes in my thesis.
Robert Baillieul has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill and Starbucks. The Motley Fool owns shares of Chipotle Mexican Grill and Starbucks.
