Among restaurant chains in the United States, I am bullish on Chipotle Mexican Grill (CMG, Financial) for the long-term while remaining cautious on McDonald's (MCD, Financial). I recently wrote an article on McDonald's where I outlined the points that make the current phase critical for the company. Maintaining my bullish outlook on Chipotle Mexican Grill, I am of the opinion that investors can consider fresh investment in the stock only after second quarter results that are scheduled for release on July 21, 2015. In this article, I will discuss the long-term positives associated with Chipotle Mexican Grill and the reason to wait for second quarter results before buying the stock.
In April 2015, Chipotle Mexican Grill announced that it has moved to only non-GMO ingredients to make all of the food in its U.S. restaurants – including all of the food at its Asian restaurant concept, ShopHouse Southeast Asian Kitchen.
To elaborate in this development, GMO are crops that have had specific changes introduced to their DNA that don’t occur naturally, using genetic engineering. According to company estimates, nearly 80% of the food consumed in the United States contains genetically modified ingredients. The negative impact of GMO might still be debated, but many countries have banned GMO and if a restaurant chain avoids using GMO ingredients, it will certainly go down positively with consumers.
Chipotle Mexican Grill has been one of the companies in the US that has focused on offering a healthy food menu and non-GMO ingredients is yet another step towards quality menu for consumers. McDonald's has been struggling and one of the factors for the company’s comparable sales decline is the menu offering that is not as healthy as Chipotle Mexican Grill or other new restaurants that are now focusing on the health factor.
In terms of capital expenditure for FY15, Chipotle Mexican Grill expects to open 190-205 restaurants during the year and a strong increase in number of restaurants on a year-on-year basis will drive revenue growth. On a long-term basis, I remain positive on Chipotle Mexican Grill and I expect robust increase in restaurants in the coming years as well.
The only concern that makes me opine that investors should wait for second quarter results before further buying Chipotle Mexican Grill is the rate of increase in comparable sales for FY15. In the fourth quarter of 2014, the company’s comparable restaurant sale increased by 16.1% and it increased by 16.8% for the full year FY14. However, in the first quarter of 2015, comparable restaurant sales increased 10.4% and the company expects low-to-mid single digit comparable restaurant sales increase for FY15.
I am not concerned about relatively low increase in comparable sales from a long-term perspective. However, more clarity on the growth potential in comparable sales will emerge in the second quarter of 2015 and that will determine the stock trend in the near term. The reason for seeking clarity on this factor is the fact that Chipotle Mexican Grill is trading at a trailing twelve month PE of 41.6 at this point of time.
For FY14, the increase in diluted EPS was 35% as compared to FY14 and this robust EPS increase justifies the PE valuation. Even in the first quarter of FY15, the diluted EPS was $3.88 and it represented an increase of 47% on a year-on-year basis. If the company’s full year outlook translates into a PEG ratio of less than one, there is likely to be more stock upside. In other words, if the EPS growth outlook is 30% to 40%, I would be positive on further upside for Chipotle Mexican Grill in the coming quarters. However, if the EPS outlook is trimmed because of relatively lower comparable restaurant sales, I would wait for some correction before long-term exposure to the stock. I have no doubt that Chipotle Mexican Grill is an excellent long-term investment, but fresh positions are advisable only after more clarity on growth in FY15.
There is another factor that can boost the company’s EPS outlook for FY15 and that factor also needs to be watched in the second-quarter results. For FY14, the company’s restaurant level operating margin was 27.2%, an increase of 60 basis points as compared to FY13. In 1Q 2015, the company’s restaurant level operating margin increased to 27.5%, representing a 160 basis points y-o-y increase and 30 basis points q-o-q increase. If margin expansion sustains, Chipotle Mexican Grill can see an additional boost to the EPS.
With these factors in consideration, I would like to conclude by saying that Chipotle Mexican Grill will remain a portfolio stock and I expect the company to perform exceedingly well in the coming years. However, in the near-term, investors can wait before considering additional positions in the stock. A healthy food menu will be the single largest factor that will drive growth for Chipotle Mexican Grill and the company has positioned itself well from that perspective.
