Chipotle Mexican Grill, Inc. (NYSE:CMG) beat earnings expectations in its results for the first quarter of 2013, with the company reporting a 13% increase in revenue versus a year earlier (nearly all from an increase in the number of locations; same store sales were up only 1%) but earnings rising 22% on several factors including SGA expenses which decreased in absolute terms. The quarter’s operations generated over $120 million in cash, of which about $50 million was used to buy back shares.
It looks to us that Chipotle is currently trading at 39 times trailing earnings after accounting for the increase in trailing EPS upon these most recent numbers. We’re certainly confident that the restaurant’s high popularity will help it to continue delivering earnings growth, but revenue growth does not look to have been too good and the same store sales numbers in particular give us pause. While some analysts have speculated that Chipotle Mexican Grill, Inc. (NYSE:CMG) will raise its prices later this year- which could increase revenue, or at least net income if volumes and therefore production costs fall- we’re skeptical that that could be a sustainable source of sales growth. The stock trades at 29 times consensus earnings estimates for 2014.
We can get a sense of hedge fund optimism about Chipotle by reviewing our database of 13F filings, which we maintain as part of our work researching investment strategies (for example, we have found that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year). Many hedge funds like the stock, and in fact Chipotle Mexican Grill, Inc. (NYSE:CMG) made our list of the most popular restaurant stocks among hedge funds for the fourth quarter of 2012 (find more restaurant stocks hedge funds love) though fewer owned it than had at the end of September. A number of market players are bearish as shown by the fact that 16% of the float is held short; hedge funds who are short a stock do not have to disclose their positions, though billionaire David Einhorn of Greenlight Capital gave a short presentation last fall. See Einhorn’s stock picks.
There are two types of peers for Chipotle: large quick service restaurants such as McDonald’s Corporation (NYSE:MCD) and Yum! Brands, Inc. (NYSE:YUM) and more premium options like Starbucks (NASDAQ:SBUX) and Panera Bread Co (NASDAQ:PNRA). Yum owns Taco Bell, while McDonalds has become concerned about Chipotle Mexican Grill, Inc. (NYSE:CMG)’s growing popularity and (somewhat) more upscale feel. Each of them currently carries a trailing P/E of 19, a level which we’d generally associate with significant growth over the next several years. However, Yum is coming off a quarterly report when net income declined compared to the fourth quarter of 2011 and revenue was only up slightly; even with this partially being caused by poor results in China, we don’t think it’s good news and think Yum should be avoided. McDonalds has been reporting very modest growth on both top and bottom lines, and so we wouldn’t consider it a value stock though we would note that it does pay a dividend yield of 3% and has little market exposure with a beta of 0.3.
Starbucks and Panera are trading at a considerable premium to those two peers, but at a discount to Chipotle Mexican Grill, Inc. (NYSE:CMG) with trailing P/Es around 31. There has been strong growth at Starbucks and Panera: Starbucks, despite its large size, managed double-digit growth rates in both revenue and earnings in its most recent quarter compared to the same period in the previous year while Panera reported 34% higher net income (with high sales growth as well). As a result these peers- Panera in particular- appear to be experiencing similar growth rates to Chipotle (particularly if we focus on that company’s revenue numbers, following the logic that in the long term increasing net margins are unsustainable particularly if sales growth primarily comes from adding marginal locations) and are valued at lower earnings multiples.
We’d conclude that even with Chipotle Mexican Grill, Inc. (NYSE:CMG)’s good quarter Panera or Starbucks- while certainly not cheap- might be better prospects for a growth portfolio. McDonalds and Yum, the other two restaurants we looked at here, carry lower P/Es but are struggling to the point that we would avoid them at this time.
Disclosure: I own no shares of any stocks mentioned in this article.
