Chipotle Is Almost Out of the Woods

NEW YORK ( TheStreet) -- Chipotle Mexican Grill ( CMG) has recovered strongly from an October share price free-fall as it became hedge fund Greenlight Capital's newest short position and, soon thereafter, significantly missed third-quarter earnings on slowing growth trends.

Since David Einhorn, head of Greenlight Capital, detailed why he was shorting Chipotle shares on October 2, the stock has risen about 15%, nearly double 8% gains made by the S&P 500 Index. Meanwhile, Chipotle shares are up over 55% since lows hit in late October, amid recovering earnings and maintenance of the company's earnings and growth guidance for 2013.

As Chipotle climbs back near all-time highs hit at this time last year, however, the company isn't entirely in the clear on investor concerns that weighed on shares in the final quarter of 2012.

The company's earnings-per-share growth is forecast to slow to single digits in the second quarter of 2013, according to consensus analyst estimates polled by Bloomberg. Chipotle's first-quarter earnings beat, meanwhile, showed quarterly revenue growth at the company slowed to just over 13%, the lowest figure since late 2009.

As profit and sales growth trails off on both a backward- and forward-looking basis, Chipotle's price-to-earnings ratio is on the rise. At Monday share prices of $369.67, Chipotle's 12-month trailing P/E stands at about 40 times earnings.

Jeffrey Gundlach of Doubline Capital recently indicated he will present a short trade in Chipotle shares at the upcoming Ira Sohn Conference. Einhorn will also be presenting at the conference, but the hedgie hasn't said what he will be speaking about.

" We think the stock is still overvalued relative to what we believe will be near-term below trendline growth," Andy Barish, a Jefferies analyst, wrote in reaction to Chipotle's better-than-expected first quarter earnings. Barish rates shares 'underperform' with a $265 price target.

Chipotle shares remain 16% below record highs of $440 a share hit last April.

Still, it may only take another quarter or two for Chipotle to dispel concerns raised in recent earnings and those pitched by vocal investors who are betting against the company's shares.

Chipotle's first-quarter earnings generally showed a stabilization in growth trends, with comparable store sales rising 1%, as cost controls and better-than-expected revenue helped to drive a significant beat.

Revenue rose 13% to $726.8 million, helping to drive profits of $2.45 a share for the quarter, beating consensus forecasts of $2.13 in EPS, according to Bloomberg data.

While food costs in the quarter rose significantly and represented about 33% of revenue, Chipotle indicated rising commodity price-based expense has run its course. Unseasonably cold weather in many parts of the U.S., the so-called "fiscal cliff" and tax increases, meanwhile, didn't dampen consumer demand for Chipotle burritos.

Chipotle's first-quarter earnings signal the company has recaptured its story to the investor community, after a half-year of uncertainty.

For instance, instead of first-quarter earnings being colored by uncertainty surrounding food expense, margins and comparable store sales growth forecasts, the most notable recent announcement by the company may have been its introduction of Patron Tequila to margarita's made in the company's stores.

Such moves highlight how Chipotle may have easy levers to pull to drive in increasing revenue from its consistently growing number of stores.

While margaritas account for only about 1% of Chipotle's revenue, the company told BusinessWeek it expects a higher figure going forward given the appeal of Patron.

Better tasting tequilas may build excitement about Chipotle for the company's loyal customers, and it may underscore to investors that the Denver-based restaurant chain is a premium brand in some key demographics.

When outlining a short position in Chipotle shares, David Einhorn said a survey conducted by Greenlight Capital showed the company's customers were vulnerable to switching to Taco Bell, owned by Yum! Brands ( YUM).

A recent brand score survey by Goldman Sachs supported some of Einhorn's assertions.

To be seen is whether Chipotle truly is a premium brand, or not. A key test for investors, is whether the restaurant chain can raise prices of popular menu items.

Wells Fargo analyst Jeff Farmer had expected Chipotle to announce a price increase in the first quarter, but now expects a 3%-to-5% increase later in 2013.

Such a move could bolster profits but test the loyalty of value oriented consumers. It could also prove or disprove some of the key pieces of David Einhorn's own analysis when shorting Chipotle shares.

Recent concerns such as slowing growth trends, commodity price inflation and valuation, meanwhile, are unlikely to surprise investors given the challenges Chipotle faced at the end of 2012.

Chipotle also has natural earnings and cash flow growth, even if trends have indicated slowing growth in profitability.

For instance, a recent presentation from Chipotle chief financial officer Jack Hartung indicated the company sees a 71.5% return from the $800,000 it costs to open each new restaurant.

Since 2009, Chipotle has grown its store count from just under 1,000 restaurants to 1,400 at the end of 2012, however, the company has seen an 80% rise in revenue and an over 100% increase in net income over that period. The company opened 183 new restaurants in 2012 and it reaffirmed forecasts for up to 180 store openings in 2013.

Ultimately, as earnings at Chipotle rise and margin pressures alleviate, the company has a path to recapturing 2012 stock price highs. Proving a premium market position by way of price increases and new products remain a key test.

Bottom Line: After first-quarter earnings, Chipotle has less left to prove to skeptical investors.

-- Written by Antoine Gara in New York

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