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Jonathan Poland
Jonathan Poland
Articles (200)  | Author's Website |

Risk-Reward With Chipotle at $300

A be-greedy-when-others-are-fearful situation

September 12, 2017 | About:

Big money managers like Ray Dalio (TradesPortfolio), Joel Greenblatt (TradesPortfolio), Frank Sands (TradesPortfolio), Paul Tudor Jones (TradesPortfolio), Ruane Cunniff (TradesPortfolio), Jim Simons (TradesPortfolio) and Bill Ackman (TradesPortfolio) have stakes in Chipotle Mexican Grill Inc. (NYSE:CMG).

In fact, Ackman has built a sizable position over 10%, which is almost 20% of his assets under management. He may start to use his 10% stake to lean on management for activist goals, which is actually good news for shareholders.

With the stock price hovering around $300, is it better or worse to own Chipotle today than five years ago? In October 2012, the stock hit $243 per share, dropping from the year high (and all-time high at the time) of $440.

From a financial standpoint, Chipotle had less revenue but more profit and a higher EPS number. Its margins were 1,000 basis points higher (10%), and the company had raving fans. With growth comes problems for any company, and while food safety incidents have damaged the company’s stock, people are still spending money on burritos and bowls.

Chipotle will likely generate $4.5 billion in sales this year, potentially at margins seen just a couple of years ago. That could mean $13 to $14 per share. That is a 21 times number for the price multiple, a value most traders would have gladly paid back in 2012. Now, close to 18% of the shares are sold short, a development that has definitely pushed the stock lower.

The underlying business is what matters

For the longest time, Chipotle framed itself as the pillar of healthy eating and fresh food. That needs to be rebuilt, but it remains on top of the industry with little competition. 

No doubt, the restaurant business is hard. Yet it is hard to imagine Chipotle will go away in the next 10 to 20 years. The company has plenty of cash ($569 million) and no debt and can produce enough free cash flow to continue its growth endeavors.

Since 2007, the company has more than tripled its restaurant count from 700 to more than 2,200. Obviously, there will be attrition as underperforming stores make way for new locations, but let’s just say that number doubles to 4,500 in the next decade. With that, Chipotle will be carrying the Mexican food segment of the fast-casual industry on its back.

Along the way, food will get more costly but still be affordable, leading to further increases in sales and profits. It is not out of the question to expect $10 billion in sales and $1 billion in profit by 2027, if not before.

That would be a yield on today’s capitalization of 11%. This growth would not necessarily justify the multiple in other stocks, but people keep paying for Papa John’s (NASDAQ:PZZA), too, and it’s the McDonald’s of pizza.

On a 30 times number, you would see more than 15% annualized returns at the current price if the company can generate that kind of performance over the coming years. Does that make it worth owning for you?

Disclosure: I have no positions in Chipotle, and no plans to buy/short the stock in the next 72 hours.

About the author:

Jonathan Poland
Thanks for reading! Since 2001, I've spent over 40,000 hours analyzing and forecasting the world's leading investments, helping investors significantly outperform the S&P 500. A few key distinctions kept coming to my attention: (1) position management matters as much as what stock you buy; and (2) buying a company's stock based on the timeframe until payback is a winning framework for both the long-term and short term gains; and (3) leveraging long term cash positions to make short term risk arbitrage trades is a practice that many top money managers engage in.

Visit Jonathan Poland's Website


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