Chipotle – Too High To Buy?

At a price of $1,042 on June 4th, Chipotle Mexican Grill’s stock (NYSE:CMG) has fallen slightly from its all time high on 2nd June, 2020. This is after the company posted a positive revenue growth of about 7.8% with a comparable sales increase of 3.3%. The impact of pandemic was felt as the comparable sales in March dropped by 16%. But the stock has risen exponentially since the results despite the Covid-19 impact primarily due to its seamless transition to digital sales, particularly delivery. Digital sales more than doubled last quarter and are now approaching 40% of the chain’s business. Despite the fact that the stock is rising, we believe Chipotle is now overvalued. Why is that? The key is the company’s revenues are expected to fall due to the pandemic in Q2 and its margins are being weighed down by the increasing digital sales (Operating margin fell by 340 basis points in Q1 2020). Our dashboard ‘What Factors Drove 260% Change In Chipotle’s Stock Between 2017 And Now?‘ provides the key numbers behind our thinking and we explain more below.

The stock price gain from $289 at the end of 2017 to $1055 at the end of 2019 is justified by a nearly 25% increase in Chipotle’s revenues from 2017 to 2019 (primarily due to higher stores and higher comparable sales). This was accentuated by an increase in Net income margin from 3.9% in 2017 to 6.3% in 2019. As a result, the net income figure rose from $176 million in 2017 to $350 million in 2019. The rise of 103.9% in EPS was also helped by a reduction of 2.6% in shares outstanding.

The rise in EPS was combined with an increase in CMG’s P/E multiple, which went up from 46x at the end of 2017 to 66x at the end of 2019.This reflects a 42% increase in the multiple fromthe  end of 2017 to the end of 2019. The multiple has gone up to 82x currently. This reflects an overall 76% increase in the multiple from the end of 2017 to June 2020.

Effect of Coronavirus

The global spread of coronavirus has led to lockdown in various cities across the globe, which has affected industrial and economic activity. This is likely to affect consumption and consumer spending adversely. Despite that, CMG’s stock is up by about 20.7% since January 31, after the World Health Organization (WHO) declared a global health emergency in light of the spread of coronavirus. However, during the same period, the S&P 500 index saw a decline of about 3.5%. Moreover, more than 95% of CMG’s total revenue comes from the US region, which is currently the worst-affected country. Many restaurants are closed, while some are running in a takeout-only mode. And lower consumer spending and consumption over the coming months will likely lead to lower demand for food and beverages. These factors are bound to hurt CMG’s revenues and we saw comparable sales fall by 16% in March. The company’s margins are also being weighed down due to higher digital and delivery cost.

We believe Chipotle’s Q2 results will confirm the trend in revenues and margin. It is also likely to accompany a lower Q3 as-well-as FY’20 guidance. If there isn’t clear evidence of the containment of the virus at the time of the earnings announcement, we believe there is a possibility that CMG’s stock could see a move to the downside. However, even if there are signs of abatement of the crisis by the time Q2 results are announced, the company’s stock is unlikely to see a major upturn, mainly because the stock seems already fully valued. CMG has outperformed McDonald’s (-9.4%) and the S&P 500 (-3.5%). In the current scenario, we believe CMG’s stock is overvalued with its P/E multiple at 82.5x.

View our dashboard analysis U.S. COVID-19 Cases dashboard for the current rate of coronavirus spread in the U.S. and forecasts on where it could be headed, based on comparison with other countries. Our dashboard -28% Coronavirus crash vs 4 Historic crashes builds a more complete macro picture of historic crashes and how the sell-off during early March compares.

Chipotle seems overvalued but there may be an opportunity when you compare Restaurant Brands to McDonald’s.

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