Restaurant giant Chipotle Mexican Grill Inc. (CMG, Financial) reported weaker-than-expected results to close out 2022 on Tuesday, leading to a sell-off. It faces multiple headwinds at this time, while its share price remains divorced from its fundamental strength.
The Newport Beach, California-based company's stock has been killing it over the past five years, gaining over 500% in value.
The primary contributing factor has been sustained growth and expansion in the company's margin profile. Revenue and Ebitda growth rates have averaged roughly 14% and 31.7% over the past five years. Most of the long-term growth is priced in, though, limiting its upside potential.
As such, Chipotle is unlikely to generate the numbers it has in the past.
Nevertheless, the company trades at a nosebleed valuation and faces stiff competition from peers, who continue to nibble away at its market share.
Growth continues despite disappointing financial results
Wrapping up 2022, Chipotle's results for the three months ended Dec. 31 came in behind analysts' estimates. The fourth quarter was a major blemish to its excellent record of earnings surprises as non-GAAP earnings per share missed estimates by 60 cents. Moreover, its $2.2 billion in revenue missed expectations by $30 million. Same-store sales growth of 5.6% also fell short of not only the market's projections, but its own.
On a more positive note, the company opened 100 new restaurants during the three-month period, bringing its total restaurant count to a whopping 3,100. Of the new locations, 90 had a Chipotlane, which is helping make takeaway orders more profitable. As the drive-thru and digital formats continue to provide greater access to customers on the go, the company, in turn, is benefitting from increased new restaurant sales, margins and returns.
In a statement, Chairman and CEO Brian Niccol commented on Chipotle's performance.
"We delivered strong growth in 2022, expanding average unit volumes and restaurant level margin, while opening the highest number of new restaurants in six years, despite facing a challenging and fluid macro environment," he said. "Our continued focus on recruiting and retaining the best people, delivering Chipotle's operational standards with delicious food prepared fresh daily uniquely positions Chipotle to successfully expand to 7,000 restaurants over the long term."
Too hot to handle
While investors are willing to give Chipotle credit for the latest growth, the fast-casual restaurant chain's valuation is still quite high. The onus is on the company to prove it can continue expanding quickly and grow into its valuation.
Chipotle is currently trading at a price-earnings multiple of 59.99. While there is momentum, making it a strong contender for a premium valuation, given how new investors are playing and the stock's recent price surge, it may not currently be the best value opportunity. That becomes especially apparent when you contrast it with companies like Yum Brands Inc. (YUM, Financial) and McDonald's Corp. (MCD, Financial), which trade at multiples of 28.91 and 32.09.
A financial recession could be imminent, so valuation should be a top priority for investors. If the Federal Reserve's tightening policies ripple through the economy, then Chipotle's sales growth will likely slow down, leading to lower rates of return.
Outlook
A recession could have dire consequences for Chipotle since its fast-casual approach targets consumers who allocate much of their discretionary spending to restaurant dining. With rising inflation and interest rates consuming more of their income, demand is likely to decline significantly. Such a result would be devastating to the company's currently profitable operations.
Analysts are bullish on Chipotle's prospects over the next couple of years, expecting double-digit expansion on both the top and bottom lines. The driving force behind the growth is the increase in store count. While the restaurant giant has performed remarkably in recent years, its stock is trading at unreasonable levels and most of its upside is priced in already, leaving little wiggle room for expansion.
Takeaway
Chipotle's stock has seen tremendous growth, with a return north of 500% over the past five years. While the last year has seen the stock trending downward, it was still ahead of S&P 500 Index. However, this outperformance comes at a hefty price as its price-earnings ratio currently stands at an incredibly lofty valuation.
The company stands out from its fast-food competitors with impressive revenue growth, high margins and a higher return on equity than most. Its balance sheet is healthy and debt free, allowing for further expansion. However, many investors believe most of the company's long-term growth potential has been priced into the stock already, limiting the upside.
Investors must pay a premium to wager on Chipotle, but with economic uncertainty and bearish market sentiment, I think it would be best to avoid such an overvalued option. Moreover, the stock market has plenty of gems trading at significantly lower prices following the broad-based market sell-off last year.
