Since the 2008 market crisis, shares of Chipotle Mexican Grill, Inc. (NYSE: CMG) have jumped a phenomenal 677%.
As the quintessential example of growth in the quick-service restaurant industry, Chipotle has built a strong reputation for serving high-quality, locally grown, organic ingredients in its burritos, tacos and salads.
That combination has given the chain a loyal and satisfied set of customers, as well as shareholders.
But that doesn't mean you should buy Chipotle stock at these levels-no matter how much you may enjoy dining there.
Chipotle's shares have become more volatile over the past year and the company now seems priced for perfection with its 36 trailing P/E and 25.5 forward P/E.
What's more, Chipotle's same-store sales are in decline, food prices are on the rise, and the chain faces even more competition.
Here's why that means Chipotle's days as a hot growth stock are likely over.
In terms of stores, here's the breakdown behind the numbers.
Chipotle's store growth has been approximately 13% annually over the past three years. In the company's recently released 4th quarter 2012 report, Chipotle opened 60 new restaurants, bringing its total count to 1,410 restaurants. And for 2013 management expects to see 165 to 180 new restaurant openings.
Now admittedly, these figures and forecasts would seem to bode well for future earnings growth.
However, a close eye needs to be kept on the trend of same-store sales in order to establish if new store expansion is justified and not just cannibalizing the sales of existing Chipotle restaurants.
Same-store sales increased by 3.8% during the 4th quarter. That is significantly below the 11.1% increase of a year ago and is down from a same-store sales gain of 4.8% in the 3rd quarter of 2012. Plus, management is now forecasting flat-to-low single-digit same-store sales for 2013.
Even still, management's long-term goal is to have between 3,000 and 4,000 restaurants. With declining same-store sales and a forecast that could come in flat for 2013, maybe management is a little too optimistic.
However, Chipotle does have two viable catalysts that could kick-start same-store sales – a recently launched catering service and an increase in menu prices.
When restaurants are packed on a regular basis as many Chipotle restaurants are, it is difficult to increase same-store sales. One way to do this is by including a catering service at each restaurant.
Chipotle launched the catering service in January and it is expected to be completely rolled out at all of the restaurants by the end of 2013. But the company is facing an uphill climb here since three of its competitors, Jack in the Box Inc.'s (NYSE: JACK) Qdoba Mexican Grill and Panera Bread (NASDAQ: PNRA), already have catering in place.
If we use Panera as an example to see how catering evolved, Panera's catering service didn't take off in an instant. It took quite some time before it became a meaningful sales driver. Panera's catering business has since expanded about 20% over the past 10 years.
So while catering may be a nice long-term focus for Chipotle, especially if it is able to deliver the same quality and choice available in its restaurants, it is still too early to put much emphasis on this unproven initiative. It does very little for them in the short-term.
Food Inflation Means Higher Prices
Rising food inflation and increased commodity prices are hitting restaurateurs and eventually will hit Chipotle's customers.
For the 4th quarter, Chipotle's restaurant operating margin slid from 26.1% to 24.6%, due to higher prices for meat, dairy products and salsa ingredients. Total food costs rose 22% and accounts for 34% of revenue.
To make up for rising food prices, Chipotle will likely increase menu prices by 4% to 5% in mid-2013. Increased menu prices should theoretically increase same-store sales, assuming the customer remains loyal to the Chipotle brand and its "high-end" fast food.
However, an increase in prices will have a troubling side-effect for the company.
Chipotle has enjoyed growth for years in its niche of the "high-end" fast food industry with little competition. But, Yum Brands Inc.'s (NYSE: YUM) Taco Bell chain has moved into Chipotle's territory with its Cantina Bell menu focused on all-natural ingredients. Although more of a traditional fast-food restaurant, Taco Bell's Cantina Bell menu offers similar meals as Chipotle at a substantially lower price.
When Chipotle does decide to increase prices, Taco Bell is bound to rustle away some Chipotle customers (if it hasn't already) who are economically strapped and are looking to stretch their food dollar.
The co-chief executive of Chipotle, Monty Moran, said, "While food costs driven by underlying inflation increased faster than expected in the fourth quarter, we're optimistic that food inflation will level off in 2013."
Granted, we could be past the drought of 2011, but I don't know what he sees that gives him that optimistic impression.
Bear in mind, Chipotle is susceptible to large fluctuations in food costs because, unlike Taco Bell and other competitors, it cannot lock in prices for the antibiotic-free meats and organic ingredients.
Competitors have the advantage of using factory farms and imported vegetables and grains to maximize margins while Chipotle, for the most part, does not. Therefore, Mr. Moran's ability to forecast food prices is a bit perplexing since many economists see food inflation as a threat in the years ahead.
So while Chipotle is honorably committed to its healthier ingredients and its "Food with Integrity" motto, it does come at a cost — the more price-sensitive consumer may be looking to sacrifice Chipotle's high-quality burrito for a cheaper burrito at Taco Bell.
Chipotle's International Expansion
If management ever wants to achieve its goal of 3,000 to 4,000 stores it will have to look overseas to do so.
And so far Chipotle has made very little impact on the global stage. The company is attempting to test the waters with a restaurant in the UK. But so far, there has not been anything to cheer about as it struggles with brand recognition.
As such, I see two obstacles Chipotle has to overcome with overseas expansion:
First, Tex-Mex or Mexican food has always struggled to find a foothold outside of North America. There are many theories as to why Mexican food is such a hard sell. But this lack of interest in Mexican food is most evident in Asia where Yum Brand's Taco Bell attempted and failed to launch restaurants in the early 1990s, and more recently pulled out of China in 2008.
This leads to the second obstacle – Yum Brands itself.
Yum owns KFC and Pizza Hut, which are quite successful overseas and were a bright spot in Yum's most recent quarterly report. If Mexican food were to ever find a place in the overseas food courts, Yum Brands already has the battle scars from attempting it and would be ready to take full advantage of this change in consumer taste buds.
Continued Growth Not As Clear
That means the path to further growth is not as straightforward for Chipotle as it once was. A lot of potential stumbling blocks look to change the company's tagline to the "former" quintessential model of a growth stock.
Growth stocks are rarely cheap since there is always a premium to pay for growth. But since the growth is what is in question, it is my belief that Chipotle shares are overvalued.
And as the chart above shows, Chipotle's share price has slowly worked its way back up from its October lows and is now bumping its head against the 200-day simple moving average.
Given its rich P/E and cloudy future, I would take that as an opportunity to SELL Chipotle Mexican Grill, Inc. before it comes back to earth.
About the Author: David Mamos brings nearly 15 years of analytical experience to the table with a background ranging from big-picture fundamental analysis to highly technical trading decisions. He began his career working as a financial advisor with Royal Alliance in 2001 and helped clients with portfolio management as well as buy-sell decisions before transitioning to the development, implementation and execution of trading strategies for aggressive investors.
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