Is Chipotle Stock a Bargain?

Everyone remembers Chipotle Mexican Grill’s (CMG) battles with E. coli, salmonella and norovirus last year.

Customers got sick, the news spread rapidly, and the former high-flying Chipotle stock plunged—over the course of 10 months—from a high of 759 to a low of 385. 

That was a haircut of 50%, enough to get the attention of bargain stock hunters—one of whom is activist investor Bill Ackman. 

Ackman, who runs the hedge fund Pershing Square Capital Management, revealed just last week that he’s amassed a 9.9% stake in the stock, making him the chain’s second-largest investor. 

Following the news, Chipotle stock jumped 6%. 

But the simple fact that Ackman owns the stock does not mean that it will automatically go up from here; Ackman is not always right

In fact, in the first quarter of 2016, the hedge fund experienced its “biggest-ever quarterly loss” of 25%, thanks in part to its big stake in Valeant Pharmaceuticals (VRX), a stock that plunged over controversy about big drug price hikes. 

Still, I admit that I’ve been watching Chipotle stock for months as the stock built a tidy base. I like the company’s food. I think it provides delicious healthy meals for a fair price—if you choose carefully. And I think there’s plenty of room for growth, provided management steers a clean course from here. 

But until last week, I was thinking that the stock might have to wait until the New Year before buyers took control. Typically, investors’ appetite for fallen angels like Chipotle stock tends to awaken in mid-December, as they look forward to a brand new year. 

But now, with Bill Ackman working to push the stock up, I’m asking myself if the stock might be attractive here in September. And here’s what I see. 

In the three months ended June 30, 2016 compared to the three months ended June 30, 2015: 

-Revenue decreased 16.6% to $998.4 million 

-Comparable restaurant sales decreased 23.6% 

-Comparable restaurant transactions decreased 19.3% 

-Restaurant level operating margin was 15.5%, down from 28.0% 

-Net income was $25.6 million, down from $140.2 million 

-Diluted earnings per share was $0.87, a decrease from $4.45 

None of that is impressive, but the fact is that some of those comparables are less bad than they were in the quarter before. In other words, the company is turning the corner. 

On the positive side, the firm did open 58 new restaurants in the second quarter, bringing its total to 2,124 restaurants, including 27 Chipotle restaurants outside the U.S. and 15 ShopHouse Southeast Asian Kitchen restaurants. 

Plus, it goes without saying that the company has worked hard to fix its quality control problems, some of which stemmed from its practice of favoring local food providers over national vendors.

In fact, as the company explained, food costs in the second quarter “were 34.2% of revenue, an increase of 110 basis points compared to the second quarter of 2015. The increase was driven by increased costs at our suppliers related to new food safety procedures and food waste costs.” 

So, the food is safer, and growing the number of Chipotle outlets (the cookie-cutter model) is still the no-brainer way to grow revenues. 

But can the company grow earnings too? 

One change that will probably help is a change of management; if Ackman has his way, there will be some changes in the ranks of the company’s directors. Right now (more than a year after the troubles started!) three of the company’s nine directors are over 70 years old! So it’s probably time for some new blood. 

Also hanging over the company are some lawsuits related to the illnesses. And Ackman can’t just make them go away. 

In any case, institutional investors in general are still in the stock. Back at the peak in 2015, there were 1,307 funds holding the stock; most recently, there were 1,237, a decrease of just 5%—though perhaps the character of these holders has shifted from growth-oriented funds to value-oriented funds. 

The only conclusion I can draw is that the company has the potential to get back on an upward track, but there’s no proof that it’s done that yet. In short, Ackman has his work cut out for him. 

The last word, however, goes to the chart, which looks like this. 

cmg-chart

You can see the tail end of the long uptrend in Chipotle stock, which peaked in August 2015. And you can see the downtrend, which appears to have bottomed in June of this year. But what you can’t see is a new uptrend, because there isn’t one yet! 

Sure, Ackman’s press release sparked a surge of buying in one day, but there’s been no follow-through since. What I’d like to see, at the very least, is the stock build a base right here in the 430-440 range for a while, and then work its way higher, demonstrating that there’s growing interest in Chipotle stock. 

Until then, I think your investment money can do better elsewhere, particularly considering that we’re smack in the middle of a strong bull market! 

Chipotle’s Competitors 

As a whole, the restaurant sector is neither hot nor cold right now. But a handful of stocks look quite healthy (many of them are hitting new highs) and earnings estimates are good! Here are a few worth looking at. 

Texas Roadhouse (TXRH) has $1.9 billion in revenues, is expected to grow earnings 30% this year and 14% next year, and pays a dividend of 1.7%. The stock plunged 12% in early August when the quarterly report revealed slowing same-store growth, but it’s recovered its composure since and is probably at a decent buying point here, still 10% off its high. 

Domino’s Pizza (DPZ) has $2.3 billion in revenues, is expected to grow earnings 20% this year and 19% next year, and pays a dividend of 1.0%. The stock is well loved; with a P/E of 43, any slip-up could lead to a big fall. But it’s been a juggernaut for years and hit new highs just two weeks ago. 

Restaurant Brands (QSR) is the Canadian company that was formed by last year’s merger of Burger King and Tim Hortons.

With $4.0 billion in revenues, it’s expected to grow earnings 80% this year (thanks to the merger) and 14% next year, and pays a dividend of 1.3%. The stock is still being accumulated by buyers discovering the “new” company, and hit new highs just two weeks ago. 

Dave & Buster’s (PLAY) offers food along with lots of in-house entertainment from sports on TV to games like Pac-Man and Skee-Ball. With $933 million in revenues from 81 restaurants in 30 states, it’s expected to grow earnings 30% this year and 14% next year, and doesn’t pay a dividend. PLAY hit a new high in early July and is 12% off that high. 

Last but not least is my favorite growth stock in the restaurant sector–mainly because it’s the youngest—which I’ll call XXXX. This chain has 845 restaurants in 39 states and seven countries, focused on selling chicken wings with sides and fries. Revenues last year were just $85 million, and analysts expect earnings growth of 19% this year and 12% next year, but I think those estimates are conservative. And of course there’s no dividend yet. 

Mike Cintolo recommended the stock to his Cabot Top Ten Trader readers just a month ago, and they’ve already got a small profit! Here’s what he wrote. (Note that analysts’ estimates have been increased since.) 

“In the mood for some chicken wings? Apparently millennials are. They’re the people who are driving the tremendous growth at XXXX, the fast casual chicken-wing restaurant franchise that derives 75% of its sales from takeout orders. Millennials—the generation loosely defined as anyone born between 1982 and 2000—love things that are fast and convenient, and there’s nothing more fast and convenient than a fast food joint that allows you to call and order takeout. ‘Our core advertising is aimed at millennials,’ the CEO told CNBC last week. With good reason—nearly half of the customers who flock to XXXX’s restaurants are millennials, higher than the average at other fast casual restaurants. And because three out of every four XXXX customers order their food to go, it allows the company to keep its restaurants small, with an average size of just 1,700 square feet. That keeps costs low, as does the restaurant’s menu, which is limited to wings, fries and a few other sides. As a result, the company just reported yet another quarter of double-digit (36%) EPS growth, and is on track for earnings of $0.54 per share this year, which would be a 15% improvement over last year and more than double what it earned three years ago. Sales were also up big (18%) last quarter, thanks in large part to a record 41 new locations. Same-store sales increased 3.1%, which shows that XXXX customers (millennials and otherwise) keep coming back for more.” 

Like Mike, I think this young stock has great growth potential. If you’d like to learn its name, and join Mike’s readers in learning about the market’s hottest 10 stocks every week, you can do that here! 

For details, click here.

But don’t delay—the bull market won’t wait!

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