Investment thesis

Given the current inflationary backdrop, I’ve focused on companies that can pass on high costs to customers (see my Tyson Foods article here). Chipotle (CMG) appeared on my radar after releasing a very strong Q4-21 and annual report, highlighted by the company’s pricing power and above-consensus guidance. The company’s new goal of opening a total of 7,000 restaurants (instead of 6,000) is ambitious but achievable in my eyes. Margins were flat and revenue growth was solid, up 26% for the full year from a strong mix in 2020. While I’m impressed with everything the company has achieved and that Chipotle’s future growth prospects remain strong, I fear investors will pile into a business that is priced just right. Even with strong revenue growth going forward, my models are trading at a fair price of $1534.88 (~2% below current levels). I’ll dive deeper into the company’s recent growth, reasons to be optimistic about the company, and finally, I’ll conclude by explaining why investors should hold at current levels.

Pricing power

In terms of pricing power, the company cited increased beef, freight and labor costs in Q4-21 due to higher than expected commodity inflation. A 4% rise in its menu price, however, helped offset those headwinds, showing Chipotle’s strong operating leverage. This led restaurant-level margins to increase 70 basis points year-over-year from Q4-20. Demand for Chipotle has remained strong despite the 4% rise in menu prices, which makes me optimistic about the company’s ability to increase prices in the future. According to Chief Financial Officer Jack Hartung, price increases will come as needed depending on the path of inflation. This gives the company flexibility as other companies struggle to pass on costs.

Digital sales growth

Digital sales grew 3.8% in Q4-21 for Chipotle, accounting for 41.6% of total revenue. Consumers continued to seek digital options as the pandemic raged and Chipotle delivered on its promises. I expect digital sales to continue to grow as the company integrates its “chipotlanes” into new stores. This allows customers to order online and collect their food through the company’s new drive-thru services. Chipotle opened 78 new restaurants in Q4-21 and 67 (85%) included a Chipotlane.

Growing orientation

Chipotle raised its guidance in Q4-21, with a new target of 7,000 restaurants (up from 6,000 previously). Given that the company expects 8-10% unit growth, it would take Chipotle 11 years (assuming a median unit growth of 9%) to reach its target.

The forecast assumes a base of 3,000 stores, which Chipotle recently reached. As mentioned earlier, I think this is achievable for the business, but investors are looking 11 years into the future if they want to envision a Chipotle with 7,000 stores in operation.

Evaluation

My assessment is based on my revenue growth assumptions, which you will find below.

My revenue estimates are driven by continued demand for Chipotle products, store expansion, and increased product offerings such as the company’s new “Chipotlane.” All of this should increase revenue in the future.

As for my DCF based assessment, I assume historical margins remain consistent with prior years, 9.69% WACC, 39.6x exit multiple on $1.37B EBITDA for the 5th year and after updating, a terminal value of 43.259 billion dollars. My EBITDA and FCF forecasts can be found in the model below. After subtracting net debt, I end up with a fair value of $1,534.88 (2% less than the company’s current stock price).

Based on these results, I believe Chipotle stocks are priced perfectly at current levels.

In terms of market multiples, Chipotle stocks are richly priced on a historical and forward-looking basis.

While revenue growth has skyrocketed during the pandemic and the company has been able to maintain profitability despite inflation-related supply hikes, I still don’t see a P/E TTM of 68 .3x or a forward P/E of 49.62x justifying the financial performance . We see the same story looking at the Seeking Alpha notes.

Chipotle has A-s for growth and profitability, but its valuation rating is an F. This concerns me because investment returns are a function of the price paid. Investors don’t have a margin of safety at current prices and that brings me to my hold reasoning.

Balance sheet

In terms of Chipotle’s balance sheet, the company is in a healthy financial position.

Looking at the chart above, cash was up 34% year-over-year, from $608 million to $815 million. This excess cash will be used to buy back shares opportunistically, as company management pointed out in its latest earnings call. Chipotle managed inventory well, up 24% year-over-year. This is impressive given recent supply chain constraints within the food industry. With a current ratio of 1.58, the company has sufficient liquidity to meet its short-term obligations.

Competitors/Risks

Since Chipotle operates in a highly saturated industry, the company is always exposed to competition risk.

Some of Chipotle’s competitors are listed below.

Although these companies are in direct competition with Chipotle, I believe the company is well ahead of the competition in terms of growth and popularity. This can be demonstrated in the company’s revenue growth since the start of the pandemic compared to its alternatives.

Chipotle was able to grow revenue nearly 2x the next best competitor, showing the competitive edge the company has.

Final Thoughts

Chipotle is a fantastic company at a fair price. The company has tremendous pricing power in the current inflationary environment and demand remains strong. My hold The rationale stems from the fact that stocks are highly valued at current levels despite recent/future growth assumptions. If the stocks fall deep, I’ll be more inclined to change my mind, but the “F” valuation tells the story itself. I’ll be sure to continue to monitor price action and update my rating as the market normalizes in the current rising rate environment. Until then, I think investors are staying away from stocks at recent levels, given my DCF shows the company is priced perfectly.