On its face, Chipotle Mexican Grill (NYSE:CMG) stock looks far too expensive. Chipotle stock trades at 47x next year’s consensus earnings per share estimate. Excluding energy names and real estate investment trusts, only a handful of S&P 500 index stocks see higher valuations. And they include high-growth tech titans like Amazon (NASDAQ:AMZN) and Netflix (NASDAQ:NFLX).
To be sure, Chipotle has executed an impressive turnaround in recent years. Earnings per share should increase more than 50% year-over-year in 2019. Wall Street, on average, sees another 29% jump in 2020.
Still, the company has done the hard work in getting past the food safety issues that damaged sales, and Chipotle stock, earlier this decade. At this point, it’s fair to wonder whether the easy money has been made both at the register and in the market. Some investors are asking that question: CMG stock repeatedly has run into resistance in recent months. That, too, suggests the rally might have run its course.
But it’s possible that Chipotle stock actually still is cheap — if the company’s turnaround actually is closer to the beginning than the end. Put another way, if Chipotle as a business can get back to what it used to be, Chipotle as a stock likely has still more upside ahead.
CMG Stock and Peak Profits
In 2014, Chipotle generated $405,000 in operating profit per restaurant. The figure in 2019, adjusted for relatively modest one-time effects, should be less half that, somewhere just south of $200,000.
That simple fact makes the opportunity here obvious. After all, Chipotle now has more restaurants. Based on guidance, the company will close 2019 with more than 2,600 locations — against 1,755 at the end of 2014. Thanks to U.S. corporate tax reform, it has a much lower tax rate. The effective tax rate in 2014 was 37.6%; the rate this year, based on year-to-date results and fourth-quarter guidance from the company, should be closer to 24%. And buybacks have lowered the company’s share count as well.
If an investor assumes that Chipotle can return to peak per-restaurant profits, it’s safe to also assume that earnings will soar. The company should end 2020 with close to 2,800 restaurants. That base would, at 2014 levels, generate $1.13 billion in operating profit. Ignoring relatively immaterial interest income, at a 24% tax rate, the burrito bar would generate approximately $30 in earnings per share.
That’s more than double the ~$14 Wall Street believes the company will generate this year. With a path toward 100%-plus earnings growth to $30, the Chipotle stock price at $837 suddenly doesn’t look so expensive.
Additional Drivers for Growth
But there’s also no reason why Chipotle’s per-restaurant earnings have to stall out at 2014 levels. After all, the company has several drivers for increased profits.
Digital sales are rising, and can both improve the customer experience and lower labor expense as a percentage of sales. Chipotle has raised prices since 2014, and may be able to do so again. New restaurant designs can lead to improved site selection and better traffic. And Chipotle continues to roll out drive-thru lanes at its locations. Third-party delivery services like DoorDash and GrubHub (NYSE:GRUB) offer another growth driver.
Put another way, had the food safety issues not happened, it’s likely that per-restaurant profits would have kept rising. And per-restaurant sales are soaring, including an impressive 11% year-over-year increase in Q3.
From that perspective, if Chipotle can restore its brand to the reputation it had in the first half of the decade, there’s seemingly little reason why the company can’t generate half a billion dollars in profit per restaurant per year. Cannibalization — new restaurants pulling sales from existing, nearby locations — is a potential issue. Still, there’s a path here toward earnings that can make CMG stock, at current levels, seem cheap.
Valuing Chipotle Stock
So can Chipotle, in coming years, get to something like $500,000 in per-restaurant profit, while operating 3,000 restaurants? That would suggest $1.5 billion in operating income, and with some share repurchases (and, again, a 24% tax rate), over $40 in earnings per share of Chipotle stock.
Starbucks (NASDAQ:SBUX), an intriguing comparison, trades at more than 29x this year’s earnings estimate. The same multiple applied here would value Chipotle stock over $1,200. That’s about 50% upside from current levels. And that suggests double-digit annual returns from CMG stock.
The flipside, however, is that even this model highlights the valuation concern with Chipotle stock at this point. The company needs to fully recover, and then some, from its past issues. The stock needs to trade at 30x earnings — hardly a cheap multiple. There’s a lot to ask here.
It’s possible that CMG stock will maintain a premium valuation. The company could move more aggressively overseas: it ended 2018 with just 37 restaurants outside the U.S. Margins may rise.
On the whole, however, it seems like a lot to ask. In the context of the opportunity here, the current valuation assigned Chipotle stock makes more sense than it seems. But investors need to truly believe that the brand is headed back to full health, and that the company will continue to execute, to see that valuation moving even higher.
As of this writing, Vince Martin has no positions in any securities mentioned.
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