At first blush, Chipotle's falling shares would validate David Einhorn's recent argument that the company is overvalued. However, in this instance, the famous Greenlight Capital short seller, who's correctly taken on Lehman Brothers and Green Mountain Coffee Roasters (GMCR), is being rewarded for being right for all of the wrong reasons.
That is if you take Einhorn's rationale for the short trade at face value.
Earlier in October, Chipotle shares were hit hard when Einhorn unveiled the high-flying restaurant stock as a new short position at the Value Investing Congress, citing the company's high price to earnings multiple and a competitive landscape marked by a resurgent Taco Bell, owned by Yum! Brands (YUM). Now, after third quarter earnings came in slightly weaker than expected, the company's share fall is turning into a rout. Chipotle's lost roughly $2.4 billion in market cap and 30% in market value in the past month.Einhorn made headlines for his theory that a new line of healthy Mexican fare at Taco Bell - Cantina Bowls -- would cut into Chipotle's customer base, hurting at the Denver, Colo-based chain's all-important earnings growth. Less emphasized in Einhorn's short thesis was Chipotle's expensive price-to-earnings multiple above 30 and the company's earnings trajectory as Chipotle turns from a novel restaurant to a mainstay in the fast-food industry. As shares fall over 14% in early trading to $244 a share - levels not seen since early 2011 - it's the company's high PE multiple, slightly weaker than expected earnings and same store sales growth that are pushing the stock lower, not the impact of Taco Bell Cantina bowls. Meanwhile, rising commodity costs damper the company's once rosy earnings outlook. Chipotle posted a $72.3 million profit, or $2.27 in earnings per share for the quarter, rising over 20% from year-ago levels of a $60.4 million profit, or $1.90 in EPS. Those figures came in slightly below consensus estimates of $2.29 in EPS, as revenue of $700.5 million fell less than 1% short of analyst estimates compiled by Bloomberg. More importantly, compared with the third quarter of 2011, revenue and profit growth slowed to about 20% from levels closer to 25% a year ago. Chipotle chief financial officer Jack Hartung attributed part of the slowdown to soft consumer confidence - national data signals confidence nearing one-year highs - and an expected rise in meat and dairy costs as the summer's drought and corn shortfall puts upward pressure on commodity costs. In weaker than expected third quarter earnings released on Friday, McDonald's (MCD) also forecast earnings pressures and highlighted a negative trend in comparable store sales. When Einhorn made his presentation of Chipotle as a short, he made it a priority to emphasize the impact of Taco Bell, shouting a company slogan "taco, taco, Taco Bell" in a Midtown Manhattan ballroom. He even beckoned a room full of analysts, traders and journalists to go to the nearest Taco Bell and see why Cantina Bowls spell Chipotle's stock demise. I followed Einhorn's advice, locating a dreary, underground Taco Bell in New York's Penn Station, and suffice to say Taco Bell's Cantina bowls are not the same as Chipotle's burrito bowls. When making his presentation, Einhorn trotted out a survey conducted by Greenlight on roughly four thousand Chipotle and Taco Bell customers to see how both chains stacked up. According to Einhorn, a majority saw little distinction between the two chains, in spite of big pricing differences. As Taco Bell rolls out its "Cantina" line of healthy Mexican food dishes, Einhorn says his short position is predicated on the company winning over price conscious Chipotle customers. More likely is that the short will pay off for the simple reason that the interplay between Chiplotle's earnings multiple and its growth outlook had the stock overvalued heading into the third quarter. At PE multiples in excess of 30, other fast-growing food and drinks chains have seen shares fall from record highs as earnings come in slightly below expectation. Notably, Starbucks (SBUX) shares have lost over 20% since the company missed earnings slightly and the stock retreated from a PE above 30.
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