Some of the best growth stock stories in recent market history have not just been technology companies but also food and beverage companies. The top food and beverage market performer over the past 20 years has been Monster Beverage (MNST, Financial), beating such market stalwarts as Amazon (AMZN, Financial) and Neflix (NFLX). Another rapid growth contender that operates in the food and beverage sector is Chipotle Mexican Grill (CMG, Financial).
Chipotle operates a popular chain of fast-casual Mexican-inspired restaurants. The company has an efficient assembly line ordering process that serves up burritos, burrito bowls, quesadillas, tacos and salads. The company uses fresh, high-quality food ingredients and its suppliers typically have to meet its stringent standards regarding sustainable farming and animal care. Although the company has experienced food safety issues in its past involving salmonella, e-coli and norovirus, those proved to be short lived and didn’t affect the company’s long-term growth trajectory once it started paying more attention to employee training and sufficient staffing to make up for the lack of artificial preservatives in its food.
The company was founded in 1993 and is headquartered in Newport Beach, California. As of Dec. 31, 2022, it operated 3,129 restaurants throughout the U.S. as well as 53 international locations. The market capitalization is $56.2 billion as of this writing.
Expansion opportunities
One of the key factors in the company’s growth story beyond just growing comparable sales is restaurant expansion. The company believes there is substantial room for unit growth beyond the current 3,200+ stores. Larger restaurant chains such as McDonalds (MCD, Financial) have over 13,000 units and there are over 7,000 Taco Bell locations domestically, for example. The company’s latest outlook calls for 255 to 285 new units in calendar year 2023. International growth is also a key factor with only 53 locations outside the U.S. at this time. Following the trajectory of Mexican fast-food leader Taco Bell, Chipotle could open thousands of units around the world over the long-term.
Financial review
The company reported a strong first quarter of 2023 with total revenues increasing 17.2% (10.9% comp sales increase) to $2.4 billion. Dine-in sales increased 22.9% and digital sales represented 39.3% of food and beverage revenues.
Total company operating margin increased to 15.5% from 9.4% in the prior year period and restaurant level operating margin increased 490 basis points to 25.6%. Earnings per share increased 84% to $10.50 from $5.70 in the prior year period. The company opened 41 new restaurants in the quarter with 34 of those locations offering the company’s new drive-through pickup lanes.
Free cash flow in the quarter was strong and totaled $334.7 million. The primary use of free cash flow was share buybacks which totaled $126.7 million in the quarter. Cash and equivalents as of the quarter's end was $409.7 million, and the company reported no long-term debt. However, the operating lease liability for all its restaurants totaled $3.5 billion.
Chipotle's CEO stated, “Our strong performance in the first quarter confirms that our focus on getting back to the basics and re-establishing Chipotle's standards of excellence is beginning to drive results. We will continue to develop exceptional people and prepare exceptional food while treasuring each guest to further strengthen our foundation for sustained long-term growth."
Valuation
Chipotle is a very expensive stock, and investors have bid up the stock price to almost extreme levels due to its consistent high growth in recent years. The stock price has increased 50% in 2023 so far. The consensus EPS estimate for 2023 is $44.00, which puts the stock selling at 46 times forward earnings. The forward enterprise-value-to-Ebitda ratio is also very elevated at over 30 based on 2023 estimates.
Using the GuruFocus discounted cash flow calculator, I get a fair value estimate of about $1,450 when using $44.00 as the EPS starting point and estimating a 15% long-term growth rate and a discount rate of 10%. Pushing one year out and using 2024 EPS estimate of $52.00 (all else the same) gives me a fair value estimate of $1,750, which is still well below the current stock price of $2,058.63 as of this writing.
The average price target by the 27 Wall Street analysts that cover the company is $2,039 with a high target of $2,270 and a low target of $1,657.
The company does not pay a dividend at this time.
Guru trades
Gurus who have purchased Chipotle stock recently include Jim Simons (Trades, Portfolio) and Jeffries Group. Gurus who have reduced or sold out of their positions recently include Harbor Capital Appreciation Fund (Trades, Portfolio) and Ray Dalio (Trades, Portfolio).
My take
The potential growth opportunities for Chipotle are well understood and have attracted a high level of interest among growth investors. Unit growth, same store growth and margin expansion will all play a role in future growth. If everything goes as expected, it looks fairly valued at current levels.
However, the company is certainly not immune to potential risks. Higher than expected food and labor costs may affect margin expansion efforts, and price increases to offset these costs may alienate consumers. Recessionary pressures may negatively impact operating results.
Despite the growth runway ahead of it, the current stock price more than reflects these opportunities. I think valuation multiple expansion will be almost impossible from these levels. It may be best for investors interested in the stock to wait for a cheaper entry point in order to maintain a margin of safety.
