Parsing Chipotle's Surge

 | Oct 19, 2013 | 1:30 PM EDT  | Comments
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After the close Thursday, Chipotle Mexican Grill (CMG) reported third-quarter earnings of $2.66 a share, missing the Wall Street consensus projection by $0.12. Food costs rose and revenue growth slowed.

In trading Friday, the shares closed up 16.1% to an all-time high.

Why did we see such a huge share jump on a disappointing bottom-line number? The market's reaction here tells you more about what it's looking for right now, and what it fears, than how it feels about Chipotle itself.

The big news at Chipotle was that the restaurant chain felt certain it could raise prices in 2014.

Does that not sound like a big deal? Well, how many companies of any sort -- let alone a restaurant company -- have any pricing power in this economy? Chipotle stands out against an environment in which even consumer giants like McDonald's (MCD) are forced to lower prices and eat the increases in raw-material costs.

If you look at the cost increases Chipotle has faced this quarter, you can see how pricing power might be a huge deal to it. Food costs climbed to 33.6% of revenue, an increase of 1 percentage point, with price rises in everything from tomatoes to corn to chicken to dairy. Restaurant-level operating margin fell to 26.8%, a drop of 60 basis points from the third quarter of 2012.

As with almost every company operating in this economy, Chipotle tried -- and succeeded -- to find ways to cut costs and increase efficiencies. For example, on its conference call Chipotle said that it had improved throughput, or the number of people served in an hour, during lunch and dinner. That can be important if traffic into the restaurant is growing, as those more efficient servers actually have more customers to serve. That was the case at Chipotle during the quarter, which saw more traffic as a result of increased advertising.

All this added up to higher guidance for 2013 -- also something that's been in short supply during this earnings season. The company raised expectations for 2013 comparable-store-sales growth (restaurants open at least 13 months) to mid-single digits, up from the previous guidance of low single digits. For the quarter, comps rose 6.2%. Chipotle also said that it plans to open 165 to 180 new restaurants by the end of 2013.

Chipotle, then, is likely to retain its spot as one of the fastest-growing restaurant chains. Overall revenue projected to grow 16% for all of this year.

Again, that's 16% revenue growth in the current struggling economy. You can see why the stock is trading at an all-time high.

That, of course, is also the problem with the stock. The shares are up 48% year to date as compared with an 18% gain in the S&P Restaurants index. The stock closed Friday with a price-to-earnings of ratio 48x on projected 2013 earnings. That's too pricey for me, since the company's 2013 sales-growth target would constitute a drop from the 20% rise seen in 2012.

So at the current stock price, I find Chipotle more interesting as an indicator of what the market thinks is in scarce supply in this economy -- and what price it's willing to pay for those scarce quantities -- than I do as a stock to put money in.

Yes, Wall Street analysts were busy raising their target price on the stock, but most of the higher targets are well below the stock's current price. Deutsche Bank, for example, raised its target from $400 to $440. Miller Tabak, for its part, went to $490 from $472.

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