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Chipotle Mexican Grill: Wall Street’s Expectations are Too High
Stock Analysis & Ideas

Chipotle Mexican Grill: Wall Street’s Expectations are Too High

Due to digital sales, Chipotle Mexican Grill (CMG) has successfully overcome the pandemic and improved its financial performance. In 2021, the revenue growth rate accelerated significantly, and margins, asset turnover, ROA, and ROE have peaked in recent years. I believe CMG is capable of further improving profitability as revenue grows. Nevertheless, the company is trading at a premium to the fair price; all potential growth drivers are already priced in. I am neutral on Chipotle Mexican Grill.

Company Profile

Chipotle Mexican Grill, Inc. operates a chain of fast-casual Mexican restaurants with a menu of burritos, bowls, tacos, and salads. Today the company owns a chain of 2,846 restaurants in the United States and 42 internationally. CMG was founded in 1993 and since its IPO in 2006, has brought investors 3556% on invested capital.

Source: TipRanks

Success During the Pandemic

March 2020 was perhaps the scariest time in the history of the restaurant business. A global pandemic began, developed countries announced lockdowns, and there were no economic stimulus measures yet. Uncertainty always scares the markets; in this case, the question was not whether the restaurant business would suffer losses but how catastrophic these losses would be.

Chipotle was fully prepared. For several years, the company has been actively developing digital sales (including delivery and customer pick-up), and in 2019, this segment generated 11% of the company’s total revenue. Due to unmet demand in 2020, Chipotle’s revenue grew by 7.13% year-over-year, and digital sales accounted for 46%. This is important for understanding the context of Wall Street’s bullish view of the company.

Financial Performance

On average, over the past five years, the company’s revenue grew by 9.90% year-over-year and reached $5,984.6 million in 2020. According to the results of the last three quarters, sales increased by 23.45%, 38.67%, and 21.91%, respectively.

Source: Created by the author

Revenue growth accelerated significantly in 2021. Investment bank analysts believe the company will maintain double-digit growth through 2028. The Wall Street consensus is as follows:

Source: Created by the author

I think this scenario is unlikely. First, we see a similar acceleration in Starbucks (SBUX), which operates its own restaurants. The acceleration in the growth rate was mainly due to the withdrawal of consumers from the lockdown; this is a temporary effect. Secondly, as mentioned above, on average over the past five years, revenue has grown by 9.9% per year; during this time, the company has grown significantly, and its business model has not changed. According to the laws of the economy, the growth rate should slow down.

Some analysts see significant potential in international expansion. Indeed, the share of international sales in revenue is tiny. However, the company may face challenges because of different food cultures, as Mexican cuisine is not famous outside North America. There are two possible paths that Chipotle can take, imitating one of these two fast food giants:

  1. Taco Bell. In the 1980s, Taco Bell attempted to enter the UK market. However, the company soon closed its restaurants due to a lack of demand.
  2. Starbucks (SBUX). China has always been a country of tea. Before the arrival of Starbucks, they hardly drank coffee in this country; the company had to build a market from scratch. Today, China is the main driver of Starbucks’ growth; the company opens an average of one coffee shop a day in this country.

It is not yet clear what the success rate of Chipotle will be in the international market. In my opinion, this potential growth driver should not be considered until it becomes clear that Chipotle is indeed capable of scaling abroad.

Due to efficient cost management and growing revenues, gross, operating, and net profit margins have increased.

Source: Created by the author

In 2019, the asset turnover dropped significantly due to changes in the Operating lease assets accounting policy. This drop does not reflect the actual operating efficiency of the business. Given the current volume of business, we expect the turnover to be in the 1.0-1.2 range in the coming years.

Source: Created by the author

In 2018, the company’s financial leverage grew significantly. The reason for the growth is the same: Operating lease assets accounting policy. Chipotle has a strong balance sheet, with net debt only twice higher than EBITDA, and EBIT is 396 times more than interest expense.

Source: Created by the author

Due to the high net profit margin and asset turnover, Chipotle reached its maximum ROA over the past four years at 10.72%. Due to the high financial leverage, the company generates a 30.72% return on equity for its shareholders. Chipotle has very high profitability.

Source: Created by the author

Valuation

Within our DCF model, I made several assumptions. By 2023, I expect the company’s revenue to grow in line with the past five years’ average growth rate. Relative indicators, including margins, are predicted based on historical dynamics and the current trend. I do not include share buybacks. The terminal growth rate is 4.5%. My assumptions are presented below:

Source: Created by the author

With the cost of equity equal to 6.76%, the Weighted Average Cost of Capital (WACC) is 6.6%.

Source: Created by the author

With terminal EV/EBITDA equal to 26.24x, the company’s fair value is $42,044 million or $1,491 per share. Thus, the company is trading at a 3% premium to its fair market value.

Wall Street’s Take

From Wall Street analysts, Chipotle Mexican Grill earns a Buy analyst consensus based on 16 Buy, six Hold, and zero Sell ratings. At $1950.62, the average CMG price target implies 25.52% upside potential.

Conclusion

Chipotle Mexican Grill knows how to create shareholder value. In recent years, the company’s profitability has been growing; ROE has reached an all-time high. By increasing revenue, Chipotle can reduce operating expenses as a percentage of revenue and increase profitability.

However, I estimate that the company is trading at a slight premium to its fair price. Wall Street’s valuation gives a bullish outlook for the company. In my opinion, analysts’ expectations of investment banks regarding revenue are too optimistic. Thus, I am neutral about the company.

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