Buy Chipotle On 38% Pullback: Growth and International Expansion

Chipotle Mexican Grill, Inc. (NYSE: CMG)                                        11/22/2012

Last Price: $275.46

VIEW: MODERATE BUY

Chipotle Mexican Grill is the largest player in the $6 billion fast-casual Mexican restaurant category. Its menu includes burritos, bowls, tacos, and salads made from higher-quality ingredients than at quick-service restaurants. Because customers can choose from four different meats, two types of beans, and an array of extras, more than 65,000 menu combinations are possible. As of June 2012, the firm operated almost 1,350 restaurants in 42 states, Canada, the United Kingdom, and France.

Sector: Services                                                                                                 Industry: Restaurants

Highlights:

Chipotle, which has about 1,350 locations, last year opened its first Asian-themed restaurant called ShopHouse in Washington. ShopHouse diners move along a service line and customize their food when ordering, similar to Chipotle stores. CMG has a market cap of $8.64 billion. The stock closed yesterday’s trading session at $275.46. In the past year, the stock has hit a 52-week low of $233.82 and 52-week high of $442.40. Technical indicators for the stock are neutral, the company has strong fundamentals and is still growing.

GROWTH AND BALANCE SHEET

Chipotle Mexican Grill (CMG) is one of the most popular and best run quick service restaurant chains in the world. CMG has improved earnings per share by 19.4% in the most recent quarter compared to the same quarter a year ago. Net income rose 20 percent to $72.3 million, or $2.27 a share, from $60.4 million, or $1.90, a year earlier, has significantly exceeded that of the S&P 500 and the Hotels, Restaurants & Leisure industry. Net operating cash flow has slightly increased to $123.06 million or 5.94% when compared to the same quarter last year. Comparable restaurant sales were up 4.8% as compared to 11.3% in 2011 and 8% in Q22012. The total Debt/Equity of 0.02% is very low and makes the stock attractive at this price level.

VALUATION

Chipotle Mexican Grill, Inc. (NYSE: CMG) has demonstrated a pattern of positive earnings per share growth over the past five years with a growth rate of 39% per year. CMG has a PEG ratio of 1.47 close to the industry average of 1.23. Current PE at CBG stands at 32.03, above the industry’s average of 18.48. The stock is currently trading at its intrinsic value of $275 this suggests that CMG is fairly valued at these levels. The beta of 0.45 implies very low volatility of the stock with respect to the S&P 500. The company is facing intense competition from Yum! Brands Inc. (YUM)’s Taco Bell, which recently began selling higher-priced burritos and bowls as a part of its Cantina Bell menu. Chipotle is beginning to expand internationally and has a lot more room for development.

RECOMMENDATION for next 6 months: We initiate our coverage with MODERATE BUY. The company has demonstrated a pattern of neutral technical signs. We feel the sharp correction in CMG shares, down about 38% from the stock’s 52-week and all time record high, as a buying opportunity for one of the few restaurant stocks with impressive growth stock attributes. CMG is down 18.44% year-to-date.

Our overall score for CMG is 7.00

For options trading we suggest:

• Buy the January 2013 call with a strike of 290.00 priced at $6.80 per contract
• Sell the January 2013 call with a strike of 310.00 priced at $2.60 per contract
• Net Debit to start: $4.20
• Maximum risk: Net debit

NEWS and CALENDAR

Tuesday November 20, 2012 – Chipotle to buy back more stock

Thursday November 15, 2012 – Chipotle Profit Trails Estimates as Sales Growth Slows

Wednesday November 14, 2012 – Chipotle Considers Big Changes to Its Brand

CMG Strengths

• Robust Revenue Growth
• Brand Name
• Customer Loyalty
• International Diversification

CMG Weakness

• Volatile Ingredients Prices
• Intense Competition

Stock valuation model

The model rates stocks from 1 to 10, with 10 being the best using a system of advanced mathematics to determine a stock’s expected risk and return. I am using different fundamental and technical factors in order to rank a stock.

Intrinsic value of the stock

Investors should buy stocks selling at a discount to their intrinsic value, and then patiently wait for the fair value of their investments to be realized.

CMG’s intrinsic value is $275.00 the current price is $275.46, the stock trades at its fair value.

Financials

The financial health of the company the higher the better, we evaluate all the financial ratios of the company.

Sentiment

Investor’s sentiment for the stock

Analyst ratings

The model assigns a value according to analyst’s recommendation for the stock.

Earnings Consistency

We are searching for EPS numbers that are better than the previous year’s. One dip is allowed, but the following year’s earnings should be higher than the previous year. CMG’s annual EPS for the last 5 years were 2.13, 2.36, 3.95, 5.64, 6.76 this type of earnings action is favorable for our model

Total Debt/Equity

The company must have a low Debt/Equity ratio, which indicates a strong balance sheet. The Debt/Equity ratio should not be greater than 20% or should be less than the average Debt/Equity for its industry

CMG’s Total Debt/Equity of 0.27% is acceptable the industry’s average is 143%.

EPS This Quarter VS Same Quarter Last Year

The EPS growth for this quarter relative to the same quarter a year earlier is above the minimum 15% that this model likes to see for a “good” growth company. Stocks with improving earnings are worthy of your extra attention.

CMG’s EPS growth for this quarter relative to the same quarter a year earlier is 19.40% above our target.

Annual Earnings Growth

This stock valuation model looks for annual earnings growth above 12%, but prefers higher than 20%.

CMG’s annual earnings growth rate over the past five years is 39.60%, well above our target growth rate.

Current Price Level

Investors should keep an eye open for stocks that are trading within 10% of their 52-week highs, as it is likely to continue in its upward trend.

CMG’s 52 week high is $442.40 current price is $275.46, is 38% below the 52 week high.

P/E Ratio

The Price/Earnings (P/E) ratio, based on the greater of the current PE or the PE using average earnings over the last 3 fiscal years, must be “moderate”, which in this model states is not greater than 15. Stocks with moderate P/Es are more defensive by nature.

The company has a P/E ratio of 32.03 well above the average industry P/E ratio of 18.48 and is above the S&P 500 P/E ratio of 15.30.

Insider Ownership

When there is strong insider ownership which we define as 8% or more, management is more likely to act in the best interest of the company, as their interests are right in line with that of the shareholders.

Insiders own 11.87% of CMG stock. Management’s representation is large enough. This does satisfy our minimum requirement; companies that pass this test are more attractive to our valuation model.

Technical Analysis

The model is using several technical indicators (MACD, RSI, MFI, OBV, position Indicators) to forecast the trend of the stock for 6 and 12 months, and assign a value.

CMG formed a bullish gap up signal, is trading in the range of $233.82 – $297.00 in the past 30 days. The Commodity Channel Index (CCI) is bullish for CMG. CMG stock has been showing support around $236.00 and resistance in the $295.00 range. Our indicators give a neutral short term view.