It’s Time to Drop Chipotle Stock Before Things Get Too Ugly
Widely followed value investor Bill Ackman bought 2.9 million shares of Chipotle (NYSE:CMG) back in 2016 at an average cost of $40-per-share. Now, with CMG stock trading in the upper $400’s, Ackman is selling some of those shares.
News flash: Value investors sell when stocks become overvalued. Granted, Ackman only sold ~800,000 shares of Chipotle stock, representing less than a third of his total position. But, that is still a sizable reduction in his overall position, and it should be a warning sign to investors.
In simple terms, CMG stock doesn’t deserve a $500 price tag. The company has a ton of unit growth potential and a new innovative leader, yes, but traffic trends are still negative and the restaurant is still getting people sick. Plus, fundamentals indicate that while Chipotle’s worst days are in the rear-view mirror, things are simply stabilizing now, not really improving.
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All things considered, a $500 price tag for CMG doesn’t make much sense. A $450 price tag makes more sense, but CMG stock price would be still be overvalued there. I peg the fair value of this stock somewhere around $425, and I wouldn’t be a buyer until the $400 level or lower.
Investment takeaway? Stay away from Chipotle stock. This stock got way ahead of itself on misplaced investor euphoria regarding a turnaround. That turnaround will be much weaker than expected. It will also take a lot longer than expected. As that euphoria normalizes, the Chipotle stock price will drop.
The CMG Stock Narrative Isn’t That Great
There a bunch of bulls out there, like Morgan Stanley, who think that CMG is in the early stages of a massive sales recovery, and that new and improved leadership will help usher in a brighter future for the damaged restaurant brand.
But, the reality of the situation is that Chipotle really isn’t bouncing back in any meaningful way.
Comparable sales growth has inflected into positive territory. True. But, traffic growth is still negative. That means that even after huge traffic declines following the company’s E. coli scare, customers still aren’t coming back to the stores.
Why? They have moved on. They stopped going to Chipotle, went elsewhere, realized elsewhere is just as good, and didn’t come back to Chipotle. Namely, the acai and poke bowl trends have surged over the past several years, at the expense of Chipotle. Just look at how much search interest share “acai” and “poke” have gained on “chipotle” over the past five years.
They are still gaining mindshare today.
It also doesn’t help that Chipotle is still battling food safety issues. Just last month, hundreds of customers fell ill after eating at a Chipotle location in Ohio. So long as this chain continues to battle food safety issues, it will be nearly impossible for management to successfully execute on its turnaround strategy.
For all these reasons, I’m not surprised that Wedbush said comparable sales trends have been weak thus far in Q3. When you keep getting people sick, you are going to have trouble driving traffic in your stores.
Chipotle Stock Is Priced for Perfection
Long-term, the company has a promising unit growth narrative. But, considering the health trend has passed up Chipotle and that food safety issues linger, this company will have a tough time driving anything better than low single-digit comparable sales growth.
That means Chipotle is likely a 10% or lower revenue growth company going forward. Margins have rebound potential, but with unit performance still off previous highs and wage pressures only building, CMG’s overall margin profile won’t ever rebound to 2015 highs.
Thus, this is a company with mild revenue growth and margin expansion potential. Putting those two together, Chipotle just doesn’t have enough earnings power to justify its current price tag. At best, I see this company netting $29 in earnings-per-share in five years.
At that point in time, CMG stock should trade at a similar valuation to McDonald’s (NYSE:MCD) because margins will be tapped out. MCD stock normally trades at 19.5X forward earnings. A 19.5X forward multiple on $29 implies a four-year forward price target of $566. Discounted back by 10%-per-year, that equates to a year-end price target of $425.
CMG stock trades at $475 today. Thus, I think stock in Chipotle has more room to fall as near-term investor euphoria regarding a turnaround fades.
Bottom Line on CMG
The time to buy this stock was back at $250. Now, with the CMG stock price hovering around $500, it is time to sell. Even under rosy growth assumptions, the stock doesn’t deserve a $500 price tag.
As of this writing, Luke Lango was long MCD.
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