Chipotle Has the Sizzle

 | Oct 28, 2013 | 3:00 PM EDT
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I'm not one to check stock prices on a daily basis. I typically do just to keep a pulse on things but the past few days I was traveling and did not keep a direct pulse. I was shocked to see that shares in Chipotle Mexican Grill (CMG) were trading above $500 apiece.

Readers of my column know that I am a big fan of Chipotle. My analysis for Chipotle years back was painfully simple: I read a few annual reports and then visited a bunch of locations. Seeing long lines everywhere was all you needed to establish that this company was for real and generating tons of sales. As a value investor, I also commented on the need to realize that buying a high-quality business like CMG at 20x to 25x earnings could be more of a value proposition than paying 10x earnings for an inferior business.

In March, I wrote of Chipotle: "How much would you pay to get a business that generates $2 million in annual sales and $570 million in operating cash flow? I'll assume no growth in sales. The maintenance capital expense is minimal for this business -- every several years or so you may have to update your equipment and spend several million dollars. If you say 10x operating cash flow, you are paying $5.7 million."

I concluded: "So if you would pay $5.7 million, then this company's 1,180 facilities are worth $6.7 billion. But if you own the actual company, you get the rights to add units at a cost of $800,000. On the flip side, the company has to incur corporate costs that would not exist if you just owned a single unit of production. Still, the growth potential is huge, so perhaps you pay $7 to $8 billion." 

Of course, I was talking about Chipotle, and when the company had a market cap of $8 billion, it was still trading for 30x earnings. That valuation metric alone would scare off many a "value" investor, but it was a misleading metric. I say misleading because Chipotle had and still has the room to add units of production (its restaurants) that cost less than $1 million to build and generate more than $500,000 in operating cash flow in the first year.

But here we are today and the company is now valued at more than $16 billion, or 50x earnings. The Chipotle sizzle has gotten exciting and the excitement has built in years of strong growth in the valuation. While I'm almost certain that Chipotle will deliver on its growth, the market values each existing restaurant at over $10 million. On average, each restaurant generates about $1.7 million in annual sales, and perhaps $150,000 to $200,000 in net profit, so you can see that Mr. Market has become very optimistic on the value of Chipotle.

This optimism is fueled by the general optimism of the stock market. I'm neither buying nor selling my stake only because I believe that at my cost basis, holding shares for years is likely a better scenario that taking a gain now. I'd be happy to add to the stake if the price took a significant decline. That being the case, today's price is at a level that I would now deem poses more risk that outweighs the superior quality of this business. If you are not planning to hold for the long run, Chipotle shares are perhaps now more sizzle than substance.

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