One Rich Burrito

 | Apr 16, 2013 | 5:00 PM EDT  | Comments
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When I heard that billionaire investor David Einhorn was shorting Chipotle (CMG), I thought to myself: This guy has made a name for himself shorting stocks that he thinks are overvalued, but this is just crazy. Who could possibly short a company that makes a burrito to perfection? But I then realized that those perfect burritos are what have caused a run-up to a valuation that is just too expensive to own at these levels -- even if Chipotle is the best of bread for the long term.

Fundamentals

This is a very good company with a fantastic management team that has delivered to shareholders. But, as we consider the stock's sizable climb since Chipotle's public debut a few years ago, there are a few other things to take into consideration. First, this stock is very rich when we compare it with its industry group. At a 40x price-to-earnings multiple, it is almost double the 21x P/E ratio carried by the broader sector.

Second, Chipotle has reported shrinking earnings per share in its past two quarters amid steady revenue figures. This can only mean a couple of things and, in Chipotles case, it points to an increase in costs. Accrued expenses rose a dramatic 36% in the fourth quarter, thus ratcheting up the company's liabilities and lowering the bottom line to investors. Overall expense management is something to watch for when the company reports its first quarter.

Lastly, I will be looking out for overall commodity expenses and how those are playing out in the company's favor.

All in all, from a fundamental standpoint, Chipotle remains a very strong company that continues to grow, and management certainly knows what it is doing. It has all the ingredients that an investor might seek in a good company. But it has nonetheless risen too far -- it has become too rich, and it deserves a breather. The technicals should paint a better picture of what we'll now need to watch for.

Technicals

The technical side tells a pretty simple story for the time being. Chipotle shares still have a bit of room to run in the near term, but they may face headwinds going forward. It all depends on the outlook and guidance that management gives in terms of how the business is growing.

Even though the stock looks expensive when it comes to a P/E, from the technical perspective I can see it getting to its next target of $363. But I don't see it reaching $411 unless we witness some drastic change, such as a unexpected revenue growth followed by expense reduction and a possible dividend. I am wondering if David Einhorn has something up his sleeve to fight for a dividend, much like how he took Apple (AAPL) to court in pursuit of a payout.

Chipotle (CMG) -- Daily
Source: Yahoo! Finance

But, overall, the technicals tell us this: The stock appears to have a bit of room to run in the short term, but we'll have to wait for guidance from management before we consider anything beyond that.

Chipotle (CMG) -- Daily Point-and-Figure Chart
Source: Yahoo! Finance

Conclusion

At the moment, it would be best to remain cautious of Chipotle, but to keep it in your watch list. As I already mentioned, because of how well the company has done for its shareholders -- expenses aside -- it is now pricy relative to its peers and to the overall stock market. It's also a good idea to keep an eye on agricultural commodity prices of such burrito ingredients as corn, wheat and soybeans. A bump in these prices means a further increase in expenses for Chipotle, and hence a further dent in the company's bottom line -- and agricultural commodities are known for suffering summer droughts if the weather gets a bit too steamy.

If you do already own Chipotle and are not generating any income due to a lack of dividend, consider selling some upside calls for cash flow generation. Otherwise, both the fundamental and the technical side demand further guidance in this name.

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