Digging In on Chipotle's Valuation
NEW YORK (
) -- Shares of
Chipotle Mexican Grill
(CMG) - Get Report
pulled back a bit on Monday after the stock was
highlighted in a Barron's article
over the weekend as a candidate for being overvalued.
The basic logic behind this thesis is sound enough. The stock has run up more than 150% in the past year, pushing its forward price-to-earnings multiple to around 35X, so yes, it's fair to say the shares look expensive, especially if that valuation implies "a smooth upward trajectory in same-store sales growth, flawless execution of expansion plans and a robust economic recovery," as the
Barron's
article states.
But what's missing is an in-depth look at Chipotle and the characteristics that distinguish it from a company like
Darden Restaurants
(DRI) - Get Report
, whose dip in the wake of its quarterly report on Dec. 20 the
Barron's
article references as a case study of what happens when a restaurant stock doesn't deliver the level of performance Wall Street expects.
So just for argument's sake, let's do a little compare and contrast between Chipotle and Darden, see if there are enough similarities there to warrant caution.
It's true: Chipotle's stock has been a rocket this year. It was up 159% through Thursday's close at $228.29, and reached a 52-week high of $262.77 in late November. But if the main knock on the stock is that forward PE ratio vs. an restaurant industry average of 19X, as
Barron's
suggests, there are a few other factors that should be taken into consideration when looking at where the business (and subsequently the stock) is heading in the months ahead.
First, Chipotle has come in ahead of Wall Street's quarterly earnings expectations for eight straight quarters, according to
Thomson Reuters
, beating the consensus profit view by an average of more than 20% over that period. Factor in that the earnings estimates are very likely to move up if the company continues to outperform and the multiple doesn't look quite as scary.
For its part, Darden has held its own vs. analyst expectations, coming in ahead of the consensus profit view in six of the last eight quarters, but it's only topped them by more than 10% once over that two-year span, with most of its beats being much more modest at less than 5%. Meanwhile, the stock has had a fine 2010 in its own right, up 33% year-to-date based on Friday's close at $46.75. That includes a pullback of 8% since the shares hit a 52-week high of $50.84 on Dec. 7, most of which followed its merely in-line earnings report later in the month.
Another thing to consider is where these two companies are at from a maturity standpoint. Chipotle is still on the upswing. Total revenue jumped 23% year-over-year in its most recent quarter, and analysts are currently projecting annual sales growth of around 16% for fiscal 2011, ending next December, for a total $1.82 billion.
Meanwhile, annual sales at Darden, whose fiscal year ends in May, are projected to rise 5% to $7.5 billion. That kind of growth isn't bad but it's nothing to crow about either in comparison to what Chipotle has been delivering, especially when you consider Darden first crested the $7 billion annual revenue mark in its fiscal year ended back in May 2009.
Also worth looking at are margins, and it appears the rising commodity prices mentioned by
Barron's
would have to be substantial to close the gap between Chipotle and Darden. Getting comparable figures from company press releases is difficult but for their most recent quarters Chipotle was able to wring a profit of $48.2 million out of revenue of $476.9 million, reporting a "restaurant level operating margin" of 27.7%, which it said was 220 basis points higher than the comparable year-ago figure.
Darden reported earnings from continuing operations of $75.8 million for the three months ended in November with sales totaling $1.73 billion, and
Thomson Reuters
data puts its reported gross margin at 22.3%. It's hard to know if the margin numbers are an apples-to-apples comparison, but it's easy enough to look at the bottom- and top-line figures and see Chipotle got the equivalent of almost two-thirds of Darden's profit out of a little less than 30% of its sales.
And finally, there's the company's growth plans to consider. Chipotle is looking to bulk up with 135 to 145 restaurant openings in fiscal 2011, on top of an additional 60 or so it plans to open in the current quarter. As of Sept. 30, the company's restaurant count stood at 1,023. So it's expanding at a healthy clip. In addition, the company issued a press release on Nov. 3 saying it's exploring an Asian restaurant concept along the lines of its ultra-efficient approach to Mexican food. An expansion in a new direction would be risky for the company but there's also the scenario that the venture might be successful to consider.
Contrast that with Darden's situation. The company's primary concepts are Red Lobster, Olive Garden and LongHorn Steakhouse. As of Nov. 28, it was operating 1,852 locations with plans for net new additions of 70-75 restaurants in fiscal 2011 (again ending in May).
Darden, which also operates the Capital Grille, Bahama Breeze and Seasons 52 concepts, isn't telegraphing a move into another concept, most likely because it's already got plenty on its plate. Its move to expand came in late summer 2007 when it inked the deal to acquire Rare Hospitality, the then-owner of the LongHorn and Capital Grille concepts.
While LongHorn saw good growth in the latest quarter with total sales rising 12.4% and same-location sales up 6.8%, the deal resulted in Darden taking on about $1.1 billion worth of long-term debt, most of which is still on a balance sheet that had $1.5 billion worth of long-term debt as of Nov. 30. Meanwhile, Chipotle's debt is negligible.
All this being said, it may very well be time to get out of Chipotle. Anyone who rode it all the way up in 2010 is sitting on some amazing gains, and the short interest of 12% as of Nov. 30 shouldn't be dismissed by retail investors. But it's also worth noting (as anyone whose held onto
Apple
these past few years knows) that just because a stock has outperformed, it's not obligated to fall back to the pack.
Chipotle closed Monday at $222.73, down 2.4%, with volume of 1.1 million running above the issue's trailing three-month daily average of around 980,000 on a day when
trading was especially thin because of the snowstorm blanketing the Northeast U.S.
--
Written by Michael Baron in New York.
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