Chipotle Has Staged a Huge Comeback, But It’s Time to Sell

Wednesday was a great day for earnings. Companies ranging from Facebook (NASDAQ:FB) to Advanced Micro Devices (NASDAQ:AMD) to Paypal (NASDAQ:PYPL) all reported really strong quarterly numbers. Their stocks jumped as a result, with PYPL advancing 3%, FB jumping 9% and AMD jumping 15% as of this writing.

CMG, too, reported first-quarter numbers after the bell on Wednesday afternoon. And all of those aforementioned post-earnings rips pale in comparison to the move made by Chipotle Mexican Grill, Inc. (NASDAQ:CMG) after its most recent earnings report — 23%!

The numbers came in way above expectations, with comparable sales growth and margins improving much more quickly than anticipated. Guidance was also strong.

On the conference call, commentary from management was bullish. Newly minted CEO Brian Niccol laid out a promising turnaround plan. Analysts proceeded to upgrade the stock.

Altogether, Chipotle’s Q1 bonanza led to a big pop in CMG stock. As of this writing, Chipotle stock is up nearly 25% on the day to above $420.

But even that move doesn’t put the CMG rebound in context. Back in early February, CMG was a $250 stock. Then the company hired Brian Niccol as the new CEO. The stock jumped. Bulls gained control.

Now, the company just reported robust first-quarter numbers. The stock is jumping again. And the bulls are running amok.

With CMG stock up 70% over the past several months and the bulls running amok, I think now is the time to sell. I continue to peg the fair value of Chipotle stock at $360. Thus, up here at $420, CMG stock isn’t supported by much outside of investor euphoria.

Eventually, that euphoria will die down. And CMG stock will drop.

Here’s a deeper look:

Great Quarter Paves Turnaround Path

Chipotle’s quarter was much better than expected, and it does show signs that the new turnaround under Niccol is underway.

Comparable sales rose 2.2% in the quarter, versus expectations for a 1.3% rise. Restaurant level operating margins improved to 19.5% versus 17.7% a year ago. Food costs fell back 140 basis points. Earnings continued on their rebound trend.

Better yet, management guided for this low single-digit comparable sales growth trend to persist over the next three quarters.

But the 2.2% first-quarter gain came against a 17.8% lap. In the second quarter, the lap falls to 8.1%. They fall to below 1% in the back half of the year.

In other words, comparables get easier as the year progresses. Thus, it is pretty likely that comparable sales growth actually heads higher for the remainder of the year from this quarter’s 2.2% base. If so, that would show that the CMG turnaround is in full swing.

Powering that sales turnaround will be a series of strategic initiatives put in place by Niccol. Those initiatives include an enhanced digital experience, a bigger focus on delivery, multiple menu innovations, and restaurant design improvements. Management is also doubling down on marketing in an attempt to make Chipotle cool again in the eyes of millennial consumers.

Those are the right steps to take. Comparable sales growth will improve over the next several quarters and years. Margins will track higher. Unit growth will remain strong. And earnings will get back to the $20-plus per share range.

But Chipotle Stock Is Overvalued Here

I’m all in on the CMG turnaround. It is working, and things will only get better from here.

But Chipotle isn’t marching towards world domination. The QSR space remains competitive. Instead, CMG is just marching towards getting better.

Over the next several years, revenue growth will likely be around 8% per year, driven by low to mid-single-digit comparable sales growth and robust unit expansion. Operating margins won’t get back to their peak 17% levels thanks to higher labor costs, but 15% margins seem achievable in 5 years. That combination of 8% revenue growth and 15% margins puts revenues and operating profits at $6.6 billion and $990 million in 5 years, respectively.

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Taking out 28% for taxes and dividing by a presumably reduced share count of 27 million, that equates to roughly $26.30 in earnings per share in five years. A market-average growth multiple of 20-times forward earnings on that implies a four-year forward price target of just over $525. Discounted back by 10% per year, that equates to a present value of $360.

Bottom Line on CMG Stock

The Chipotle turnaround everyone has waited so long for is finally here. But at $420, CMG stock is supported more by turnaround euphoria than turnaround fundamentals.

As such, once the euphoria dies down (and it inevitably will), CMG stock will drop.

I was a buyer below $270. I was a bull at $320. And now I’m a seller and a bear at $420.

As of this writing, Luke Lango was long

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