Has Chipotle Lost Its Sizzle?

Submitted by Randall Radic as part of our contributors program.

In the last few days, Chipotle has been all over the news, especially the business channels. Chipotle is a chain of laid-back Mexican restaurants. They serve stylish laid-back food prepared on shiny foodservice equipment. The company is run by a group of natural-food evangelists who believe their product can and will revolutionize the way people eat. And they might be right, for natural and organic foods are riding atop a wave of popularity at the present moment. Still, the question is, are people willing to pay the price premium such foods command.

Some people don’t think so. David Einhorn, who manages a hedge fund, is one of those people. Einhorn announced a few weeks back that he was shorting Chipotle’s stock. He stated that Chipotle’s primary problem was Taco Bell, whose new ‘Cantina Bell’ menu was going to blow Chipotle’s good ship lollipop right out of the water.

Unfortunately, Mr. Einhorn’s forecast came true. The company reported third-quarter 2012 earnings last Friday. Needless to say, the report left investors gasping for breath. The stock fell more than 15% on Friday, which means that over the past few months Chipotle has experienced a 40% decline. In April, the stock was trading at $442, before dropping to $200. It rebounded to $239 as of Wednesday.

However, the picture is not quite as gloom and doom as it might appear. Chipotle reported 18.4% revenue growth this quarter, with sales jumping 4.8%. And that’s not bad, especially in the current economic climate. However, they do indicate slumping numbers in each area, when compared to previous quarters.

CFO Jack Hartung has indicated that Chipotle will increase its prices in 2013, if costs keep going up. The company will be forced to pass on the higher cost of doing business to the consumer. If that happens, some analysts believe that Taco Bell, which most analysts don’t think is a real threat currently, could become a real problem. Most analysts believe that a menu price increase by Chipotle would leave many of its present consumers with a serious case of indigestion. A Chipotle burrito runs around eight dollars, and that’s without guacamole. When that price goes to ten dollars, it may reach its tipping point, which will serve to hinder Chipotle’s momentum.

Even with the sharp drop in stock price and the threat of menu price increases, the market doesn’t seem to agree, because Chipotle’s stock is still priced for growth. Analysts expect around $10 in earnings per share over the next four quarters. And the price-to-earnings ratio is still at 24, which is pretty darn high for a company that just predicted “flat” sales. Admittedly, the P/E was at 60 at one point, which may have been too high. Nevertheless, the company is still planning on 160 new locations per year, and up until recently had produced fantastic profits.

A few analysts are touting McDonald’s as a better investment. But McDonald’s also missed their earnings targets, and have a forward P/E of around 14 or 15. Chipotle, at 24, looks like a better bet. Sometimes unwarranted pessimism drives a stock down more than anything. In the case of Chipotle, that may be what’s happening.