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Chipotle's Still Sizzling Ahead of Earnings

NEW YORK ( TheStreet) -- If you want to define "chipotle," as in Chipotle Mexican Grill (CMG - Get Report), just take look a the company's stock price, which is up close 20% over the past three months and is up 50% year-to-date. At a price-to-earnings ratio of 46, more than twice the valuation of Yum! Brands (YUM), these shares carry some eponymous heat.

I don't deny that Chipotle has built itself into a leading fast-casual restaurant that's posting strong growth and above-average margins. To the extent that the company now deserves a P/E that is almost 3-times that of McDonald's (MCD), I don't believe it does. Not to mention this leaves absolutely no margin for error in an environment where discretionary remains unstable.

I will credit Chipotle management for growing same-store sales and managing costs. On Thursday, when Chipotle reports third-quarter results, the company will get a chance to convince the Street that the valuation is deserved. Analysts will be looking for earnings of $2.78 per share on revenue of $820.28 million, which would represent earnings and revenue growth of 22% and 17%, respectively.

Given that Chipotle has consistently posted double-digit profit and revenue growth, the Street is not expecting the company to divert much from its historical performance. What I am interested in (among other things) is how the company continues deal with the rising costs of chicken and beef from suppliers like Tyson (TSN).

If anything has kept the stock sizzling, it's been Chipotle's strong restaurant-level margins, which registered an astounding 27.6% in the July quarter. While that number is significantly higher than both McDonald's and Yum! Brands, I did notice a 160-basis point decrease. Chipotle has called that a "trivial" decrease. But let's not forget that it was preceded by 110-basis point decrease in the April quarter.

Now, I don't want to make too much this, but should restaurant-level margins decrease again on Thursday, it then becomes a trend. My issue here is that, while Chipotle's overall profit margins still remain high relative to its quick-service peers like Panera (PNRA) and Qdoba, which is owned by Jack in the Box (JACK), this is because Chipotle operates a premium-priced restaurant.

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