|Chipotle Mexican Grill: From Overvalued to Efficiently Priced|
By Ronald Thomas, CFA OCT 22, 2012 4:35 PM
Back in February, Minyanville's Ron Thomas made the case for the stock price, which has been reached today.
[Editor's note: This story originally ran on February 24. We're re-running it since author Ron Thomas made such an articulate case for Chipotle being overvalued at its then-$387 stock price. Reached today for comment, Thomas said, "At $238, it has essentially reached my $236 valuation published in February. I believe that it is now efficiently valued."]
MINYANVILLE ORIGINAL I was doing some housekeeping recently and noticed some large-cap stocks I didn't have models for, including Chipotle Mexican Grill (NYSE:CMG). So I put Chipotle’s $387 stock price into my three-stage earnings-per-share discounting model to see what was imbedded in the price. I used the average sell-side estimates of $8.70 and $10.84, respectively, for 2012 and 2013, in my model (standard MBA school five-year growth rate, followed by five-year decay in growth rate, ending in a terminal growth rate). The risk-free discount rate was 4% to account for the 30-year treasury rate being below normalizable levels, and present administration’s policies making treasuries look anything but risk-free. My risk premium was 7%, which is fairly standard for a casual diner or really any restaurant chain other than McDonald’s (NYSE:MCD). Terminal growth rate was 1.5%. You non-technical investment types can more or less ignore this. (I know what I am doing here.)
So, I got a five-year EPS growth rate of 31% per year. Wow.
There are some really gross shorthands I use to see if a stock I am not familiar with is overvalued by a lot. One is to look at the average brokerage firm analysts five-year growth estimate, which is always too high and more relatively above reality for high-growth companies. The sell-siders are predicting 21%. Using 21% says that Chipotle is worth $247, or 36% below its present $387.
Another shorthand is to look at the sell-side price targets. The low, median, and high numbers for Chipotle are respectively $260, $400, and $450. A very good rule of thumb here is that, if the stock price is anywhere near the sell-side median price target, it's probably moderately overvalued.
Now let's go to restaurant fundamentals. I recently read a sell-sider’s analysis of potential store saturation for Chipotle. By his analysis, which I judge to be valid, based on his assumptions and the data he used, Chipotle, with 1,226 units in the US, can grow to 3,500, an increase of 134% in his base case, or can grow to 4,200 units, an increase of 181%. In that same analytical piece he estimated that it could reach a $33.00 EPS level by 2020. He did not say how many units it might have by 2020, but it is reasonable to expect that his number was related to the growth path implied from his base level of saturation. So, what five-year growth rate level gets Chipotle to $33 in 2020? The answer is 20%, which implies a $236 price. Not really accounting for SG&A leverage, but grossly multiplying the $33 EPS by 1.2 for the bull case saturation (4200 units/3500 units=1.2), results in $39.60, which implies a 24% five-year growth rate and a $282 price, 27% below the current $387. Chipotle, like Panera Bread (NASDAQ:PNRA), the other giant of fast casual dining, was a great restaurant idea that came at the right time. While the consumer was getting to appreciate more varied upscale food than burgers, he was being squeezed by very little increase in real income in the late 1990s and early 2000s. Before the 2008 recession, you could move up from quick service restaurants to fast casual, and after 2008, you could move down to fast casual from casual dining.
But the competitive landscape of the fast casual segment is really not normal and has to change. Panera and Chipotle are the giants of the industry segment. That makes no sense. Did customers suddenly become enamored of just Mexican and upscale subs and panini sandwiches? I believe that the 2008 capital markets meltdown, coupled with the hunkered down consumer, has made it very tough to get capital for most new restaurant ideas. Just looking at the ranks of quick service restaurants and casual diners that flank the fast casual segment, you have to believe that there will be lots of other varied food concepts coming and that maybe three or four will be big hits with consumers.
The implication is that the present profitability of Chipotle’s units and the numbers used to figure potential saturation and EPS growth rates are too optimistic to use in valuing the stock, or that huge competitive pressure has to be put into the models for later years’ results.