Is Chipotle Stock Overvalued?

Chipotle Mexican Grill, Inc. (NYSE:CMG) was well prepared when the coronavirus outbreak shut down other restaurants.

This California-based fast-casual Mexican restaurant chain spent much of the late 2000s and 2010s combatting a variety of viral and bacterial infections in its food. This meant it already had standards in place that the competition had to catch up to.

Combined with investment in technology and easy pick-up orders for customers, CMG share price rebounded to pre-crash highs, so is Chipotle stock overvalued?

From norovirus to hepatitis, E. coli, and Salmonella, Chipotle management has seen it all. It was hit especially hard by a series of outbreaks in 2015 that included pretty much everything on this list. Its stock price tanked for the back half of the 2010s, but it skyrocketed to gain over 400 percent from its $300 lows in 2017.

What strategic ingredients did Chipotle use to go on such a healthy share price run? 

Why Chipotle Stock Went Up

Chipotle was founded in Colorado in 1993 and by the end of the 20th Century, McDonald’s (MCD) was a major investor.

This helped the company scale its franchise model into over 2,700 locations. By 2006 the company held its initial public offering (IPO) and McDonald’s sold its holdings.

That’s when the food supply chain problems started attacking the company and suppressing its growth potential. From 2008 through 2018, there were over a dozen major outbreaks, along with two data breaches and a class-action lawsuit regarding its menu.

It forced the company to undergo changes that became mandatory for everyone in 2020.

While this held the company down through the 2010s, its poised to break out in the 2020s after outperforming competitors during a bleak economic period for most of the food service industry.

From delivery to curbside pickup, Chipotle long followed what we now recognize as social distancing health precautions.

The proactive approach gave it a head start and helped it outperform the market with better operational costs and overall customer service scores. Here’s a bird’s eye view of Chipotle’s post-pandemic financials.

Chipotle Financials: Is The Company Fully Valued?

Chipotle has a lofty P/E ratio of around 150x depending on what day you look. And a discounted cash flow analysis suggests an intrinsic value of $1,386 per share is fair.

Bargain hunters should look to significant discounts below that level before considering the shares cheap.

Pandemic aside, the company still gained 60 percent since the beginning of the year in the toughest restaurant environment in a generation. The COVID-19 outbreak caused widespread city shutdown orders that halted dine-in services for restaurants worldwide.

Same-store sales in the U.S. restaurant sector were down 12.3 percent in the third quarter, but Chipotle’s were up 8.3 percent over that same time frame. This is in part because the company was one of the first to integrate its digital footprint into third-party delivery services like DoorDash.

Because of this, Chipotle’s digital sales were up 202.5 percent from the prior year, making up nearly half of the company’s overall sales for the quarter.

Operating margins were down to 19.5 percent, due to higher delivery costs during the pandemic, underlining a possible problem for restaurants and delivery services moving forward.

Is Chipotle Valuation Too High?

Not only is Chipotle enjoying a record high market capitalization and revenues, but it’s also trying to double its retail footprint at a time when most restaurants and retailers are scaling back.

It plans to add 200 stores in 2021 and continue scaling from there. It sounds audacious, but would still be half the store growth of rivals like Subway and McDonald’s.

It costs approximately $850,000 to open a new location, which puts a $170 million expense burden on the profit and loss statement. That shouldn’t impact it too much, as the pandemic is expected to drag well into 2021. But its market capitalization is a bit lopsided compared to a rival like McDonald’s.

Another point of concern is that Chipotle’s P/E ratio is even higher than high-margin coffee provider, Starbucks (SBUX).

This gives bearish analysts reason to doubt the company can maintain its market capitalization over the next year. There is a reasonable chance CMG share price growth will begin to slow as other restaurants catch up to the digital delivery revolution.

If it can continue its sales growth and expansion as planned, investors will breathe a sigh of relief.

Will Chipotle Stock Drop?

Nobody yet knows how the pandemic has changed consumer dining habits. What is clear is that digital and delivery are more important than ever before. Morgan Stanley estimates the industry’s growth was accelerated by three years, and work-from-home trends are also on the rise.

This is putting more pressure on independent restaurants, which may eventually consolidate to create a new competitor to Chipotle.

It will also continue giving a cut of profits to delivery services, which will eat into the bottom line (assuming being listed on marketplaces like UberEats, Postmates, and DoorDash gets more expensive).

And a recession in 2021 could lead to people cooking and eating at home more. Eating out costs over three times as much as groceries to cook at home.

Meanwhile grocery stores are pushing into the pre-made meal market. Each of these factors could cause Chipotle’s stock to bleed money like a badly made burrito.

Is Chipotle Stock Overvalued? The Bottom Line

Chipotle rebounded from the 2020 market rattle to gain 60 percent of its market value for the year. Much of this is because it was beaten so hard in the 2010s that it was forced to implement changes that normalized in 2020. Now that its digital business accounts for half of revenue, it is trying to grow its retail footprint.

This could prove to be an expensive move in a turbulent real estate market coming up over the next two years. And it still won’t have a fraction the footprint of a rival like McDonald’s (MCD), or even Starbucks (SBUX). It also has a much higher P/E ratio than its peers.

If the company continues to deliver revenue growth, it will justify its elevated valuation. That will be easier said than done if a second government stimulus doesn’t get people spending around the world.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.