Chipotle Mexican Grill (CMG) has seen tumultuous times in recent years or perhaps the past decade, as the secular growth story behind the company has been very strong, with some ups and downs.
Coming out of the economic crisis a decade ago, shares traded in their forties as a multi-year momentum run pushed shares up to levels around $750 in 2015 amidst very strong growth, accompanied by some serious valuation multiple inflation.
A correction to that move accompanied by well-documented health issues pushed shares down to a low of just $250 in early 2018, before shares rose to levels comfortably above the $900 mark in February. Of course, investors have seen a correction with shares losing half their value in response to the COVID-19 outbreak, as progress on the disease’s spread and momentum in sales of online channels makes that shares have seen an impressive rebound to $882 at the moment.
So Where Are We?
Before judging where we stand there, let’s look at the 2019 results as a starter. The company reported its full year results in early February. Results were relatively strong with full year sales up nearly 15% to $5.6 billion, driven by 11% comparable sales growth of which about 7% can be attributed to an increase in transactions. All these metrics have been even a few points stronger in the fourth quarter and indeed are quite impressive.
Of further interest are the digital sales which rose 90% for the year, making up 18.0% of sales. While digital sales growth slowed down to 78% in the fourth quarter, the contribution to total sales grew towards 19.6%.
Strong growth in sales resulted in some real leverage, notably in terms of labor and occupancy costs. The company boosted operating margins from 5.3% to 7.9%, with operating profits increasing to $444 million, translating into net earnings of $350 million, as earnings on the bottom line doubled compared to the year before thanks to margin expansion and sales growth.
With 28.3 million shares outstanding, reported earnings came in at $12.38 per share, and it goes without saying that this translates into very steep multiples. While the company reports a very strong net cash balance of $480 million, equal to about $17 per share, Chipotle has to deal with the same accounting policies as everyone else, resulting in over $2.6 billion in lease liabilities appearing on the balance sheet. Factoring in the $17 per share in net cash, operating assets go for $865 per share, translating into a very steep 70 times earnings multiple, as the boom times of previous years have returned.
For 2020, the company originally outlined a solid guidance as it aimed to open 150-165 new restaurants. With a restaurant count of over 2,600 at the moment, these openings add about 6% to reported sales, assuming they are equally productive as current restaurants. Combined with a mid single-digit increase in comparable sales growth, this should easily allow for double-digit sales growth and some modest margin expansion.
Assuming 11% sales growth in total (6% openings + 5% comparable growth), that works down to $6.2 billion in sales as operating earnings could surpass the $550 million mark if a percent increase in margins would be achieved, laying out a road map for earnings to approach the $15 per share mark, despite a slightly higher tax rate.
Then of course the Corona crisis unfolded in full swing as the company took a lot of measures to keep stores afloat, although resulting in quite some costs incurred. Examples of this include free delivery being offered in the month of March, partnering with Uber Eats, as well as continuation of free delivery through the month of April and providing food to health workers.
Late April, the company reported its first quarter results, in a report which was well-received by the market. Total revenues for the quarter rose by nearly 8% to $1.4 billion, with comparable sales up 3.3%, yet transactions were actually down a bit.
The quarter really was a tale of two periods with comparable sales up more than 14% in January and February, while March was another story, with comparable sales down 16.0%. Digital sales growth accelerated to 80% which increases the share from digital sales to 26% of total sales. Sales deleveraging in March and other charges incurred mostly relating to the crisis made that adjusted earnings fell by 9% to $3.08 per share.
Further anecdotal evidence in the press release and call is comforting. This reveals that comparable sales fell an astonishing 35% in the final week of March, rebounding into negative mid-teens by the middle of April, as momentum appears to be turning for the good in recent weeks. Operating margins fell on the back of higher labor costs, mostly associated with the March deleveraging and additional measures results in higher employee and general costs.
If the Corona crisis had not happened and the company would deliver on its $15 per share guidance (which can be deduced from the original 2020 guidance) shares are very expensive at nearly 60 times earnings, even after backing out the net cash position already.
Comforting is that the company believes that the delivery business will be strong, even if the crisis subsides. Furthermore, the delivery channel made up about 60% of sales during the month of April as added scale and foregoing of real estate footprint might actually provide a long-term boon to the business, yet that requires a long way.
During the great times when the company was growing at very impressive rates, the company reported operating margins around 15%, as the company is still far removed from those levels. The company has seen margins under pressure amidst growth in less productive locations, but mostly due to reinforcements in the supply chain to avoid food quality issues, and among others additional costs incurred with delivery options.
So in the absence of the Corona crisis, the company would still post lower margins than seen in record years, yet if we for a moment believe the company could have posted 15% margins otherwise in 2020, operating profits could have come in around $900 million. Including some modest interest costs and assuming a 25% tax rate, this business might be able to report net earnings of $700 million, yet that is in the absence of the coronavirus and returning to historically high margins.
Such a number would result in an earnings potential of $25 per share, far above the earnings number which the company implicitly guided for around $15 per share when it initially guided for its 2020 results. Reality is that margins have been falling amidst wider delivery options, improved quality, among others.
Even in such a scenario, which is a far rosier scenario than the 2020 guidance, let alone the current situation, shares trade at an earnings multiple in the mid-thirties, simply very high, despite solid growth and solid growth prospects.
Having been both bullish and cautious on Chipotle in the past, I feel that current levels are anything but a prudent level, especially after shares have nearly doubled in recent weeks, as I can hardly come up with a scenario, let alone a realistic scenario which can justify the valuation here.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.