Chipotle Mexican Grill Inc. (NYSE: CMG) has been one of the greatest restaurant stock stories of the past decade. It is also one of the top destinations to eat. Unfortunately, Chipotle seems to be suffering from some of the same issues now that mature restaurant chains suffer from. If things do not get righted soon, Chipotle’s shares could easily be overvalued by about $200 or more.
News broke this last weekend that Chipotle is being probed in Oregon and Washington for an E. coli outbreak that has hit 22 people in the area. Investors and Chipotle consumers do not need to worry that this will mark the end of Chipotle at all. That being said, Chipotle is at a crossroads in 2015 where high valuations and growing pains may be larger than they seem.
The good news is that this is not set in stone. Chipotle can recover. The bad news is that Chipotle’s shareholders have to be considering some serious valuation risks ahead.
It was not that long ago that Chipotle was voted as one of the top destinations for couples to go out on a date, even a first date. But Chipotle’s growing pains are starting to sound like they come with the hallmarks of all other restaurant chains after they reach a certain size. As a reminder, Chipotle was spun out of McDonald’s Corp. (NYSE: MCD) in the prior decade (2006).
Chipotle recently had to stop selling carnitas at one-third of its restaurants after reports of an audit identified that one its food suppliers was not complying with Chipotle’s standards on animal welfare. Chipotle also has been attacked recently over GMO food claims and that some of Chipotle’s cooking is outsourced to a company that also makes McNuggets and McRibs. Then there is also the grass-fed beef issue from Australia and use of trans fats, per a BuzzFeed report this summer.
So, while this is obviously not the death of Chipotle, that does not at all mean that investors better be more concerned than diners. Chipotle shares were right at $640 before the news broke, the stock fell to $624 on Monday and was back up to $629 on Tuesday. It is one thing that a Chipotle diner can spend less than $10 at a meal, but another thing that the price of one single share of stock represents a whopping 63 or more meals at $10.
Chipotle’s stock price of $640 prior to the E. coli news was against a 52-week range of $597.33 to $758.61. After a pullback of that magnitude, Chipotle’s consensus analyst price target of was $757.22, and that target is down less than $1.00 so far. That just feels too high for the pullback we have seen and for the issues that Chipotle faces today. We are also concerned about its growth rates, and that comes with supply chain issues ahead. Some companies can keep up with their growth, but suppliers and availability of high-quality products can be a different issue entirely.
Chipotle’s market cap is also right under $20 billion, even after the pullback that has been seen from the 52-week high. That would represent about four times a blended 2014 to 2015 annualized revenue expectation.
Then the $640 share price before the news represents a P/E ratio valuation of 37 for 2015 expectations and 31 for 2016 expectations. That isn’t exactly cheap for a stock market that is trying to decide if the S&P 500 should trade at 15 times or 17 times expected earnings.