Einhorn’s Oct. 2 revelation at the Value Investing Congress that his firm took a short position in Chipotle had a milder effect on its stock price that his previous short announcements – it fell 4.2 percent to $302.96 that day. Chipotle is the upscale burrito restaurant that focuses on fresh, sustainably grown, humanely raised, often organic ingredients. Since its founding in 1993, it has expanded to 1,350 restaurants and seen its stock soar 593% since going public in 2006.
Though approximately 750,000 customers swarm Chipotle every day, Einhorn said he sees trouble ahead for the company, highlights of which include:
· Increased competition from a new higher-quality, cheaper menu at Yum! Brands’ (NYSE:YUM) Taco Bell, and other copy-cats
· A constrained ability for Chipotle to raise prices due to increased competition
· Rising food prices (grains have risen and meat prices are likely to rise)
· A “nosebleed valuation that does not leave room for deceleration”
His primary concern, increased competition from fast-food chain Taco Bell, stemmed from a new menu the company is introducing and results of a survey Einhorn’s team conducted. The new menu, designed by a contestant on the television show Top Chef, contains less dubious ingredients than Taco Bell’s other fare and at under $5 is more affordable than Chipotle, where a burrito is around $8. He said a survey of consumers confirmed that many Chipotle customers would switch.
Several weeks after Einhorn publicly delivered his short thesis, on Oct. 18, the company discussed price increases in its third quarter 10-K. Sales, it announced, increased 18.4% to $700.5 million. The increase was composed of new restaurants and a 4.8% increase in comparable restaurant sales. Comparable restaurant sales increases were due to increased traffic, and 1.2% came from increased menu prices.
Chipotle raised prices in its Pacific region in the first quarters of 2012 and 2011, and raised prices everywhere else in the summer of 2011. It does not expect to raise prices further in 2012.
The company also addressed the impact of rising food prices in its 10-K:
Our food costs decreased as a percentage of revenue during the first nine months of 2012 as compared to 2011 as a result of the impact of menu price increases and relief in avocado prices, partially offset by inflationary pressures on many of our ingredients, particularly chicken and beef, as well as the impact of purchasing more naturally raised meats. We expect that food cost inflation will persist for the remainder of 2012 and will continue into 2013 and that our food costs as a percent of revenue will increase.
Food, beverage and packaging costs were 32.3% of revenue in the first nine months of 2012, compared to 32.7% of revenue in the same period of 2011.
Regarding the high valuation “that does not leave room for deceleration” Einhorn cited, Chipotle has a P/E ratio of 34.01, P/B ratio of 7.2 and P/S ratio of 3.7, with a market cap of $$9.22 billion. Its P/E ratio is down from as high as over 60 earlier in the year.
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In the past five years, the company has grown revenue annually at the rapid pace of 22.8%, EBITDA at 33.2%, free cash flow at 133.6% and book value at 17.3%. (See Chipotle’s 10-year financials page here.)
Sales indeed appear to be slowing recently. This year, comparable restaurant sales increased 12.7% in the first quarter, 8% in the second quarter and 4.8% in the third quarter.
As of the third quarter, the company appears set to meet its mid-single digit comparable restaurant sales growth target for 2012. In 2013, it is expecting flat to low-single digit comparable restaurant sales.
The company, however, plans to open more restaurants next year (165 to 180) than it expects to open in 2012 (155 to 165). In addition, it is introducing a new Asian-inspired concept, ShopHouse Southeast Asian Kitchen. It already has two of the restaurants in Washington, D.C., and in 2013, expects to introduce the ShopHouse in the Los Angeles area.
“While building Chipotle remains our primary growth strategy, we’ve seen great interest in ShopHouse in Washington,” said Steve Ells, founder, chairman and co-CEO at Chipotle.
Einhorn’s concerns about the Chipotle’s high valuation being unable to sustain a deceleration in growth were affirmed when its stock price dropped 15% on announcement of its third quarter results. The price, however, has already rebounded about 19% to $290 per share in Friday trading – higher than the price the day of the release.
See David Einhorn’s stock holdings in his portfolio here. Also check out the Undervalued Stocks, Top Growth Companies and High Yield stocks of David Einhorn.