This high-flying stock could tumble 50%

After a spectacular run, it's time to take profits in Chipotle Mexican Grill. Here's why.

By StreetAuthority Oct 25, 2013 4:00PM
File photo of Chipotle Mexican Grill. © GUS RUELAS/Newscom/RTRBy Adam Fischbaum

Polyester-draped family photos aside, being a child of the 1970s was pretty cool in some ways. There were many things to dislike -- bad hair, bad clothes and a lot of terrible music -- but the TV shows weren't too bad.

For several years in the mid-'70s, my family used to sit down faithfully on Tuesday nights in front of our ridiculous console TV set to watch "Happy Days." The series ran well into the '80s, but most viewers gave up on it after the famous episode in which the Fonz jumped a shark while waterskiing. The series went downhill fast after that, giving rise to the awesome phrase "jumped the shark," which is used to describe when something has peaked and rolled over.

Stocks, of course, are highly capable of jumping the shark.

Let me be upfront. I've never been to a Chipotle Mexican Grill (CMG) -- but being in the investing biz, I'm familiar with the brand, thanks to the financial media's nonstop gushing about the company and its stock. Clearly, Chipotle is a bona fide rock star.
A double in two years is impressive, but these numbers are unsustainable. I don't care how good the food or the business model is.

What's in those burritos?

American diners are loco for Chipotle, a pioneer in the convenient-casual dining space. Convenient-casual is described as a having a little higher quality than fast food but at about a 20% cost savings to traditional casual dining such as Red Lobster or Olive Garden, brands owned by Darden Restaurants (DRI). And the concept has worked like crazy, driving three consecutive years of 9%-plus same-store sales growth. The company now boasts nearly 1,500 units.

But this growth just isn't sustainable. The numbers are super-rich here. Chipotle sports a $500-plus stock price, a trailing price-to-earnings (P/E) ratio of 52 and a forward P/E of 49. That means investors are willing to pay around $50 for one dollar's worth of Chipotle's current earnings. That's confidence -- and historically, valuations that lofty just aren't realistically sustainable. (Anyone remember the tech bubble?)

Let's look at Chipotle's growth plan. The company has opened 129 new stores this year, 37 in the third quarter. That's a big expansion, and despite the company's focus on smaller stores, which are more cost-effective to open and operate, if you've seen a Chipotle -- with their modern designs and expensive-looking fixtures -- you know they're not done on the cheap.

Chipotle's growth strategy brings back memories of a similar push by Starbucks (SBUX) early in the past decade. Starbucks' stores were high-tech, expensively appointed -- and everywhere. Between 2006 and 2009, the company closed 600 stores due to overreaching and oversaturation.

Starbucks' folly had a noticeable impact on earnings growth, which, naturally, had a negative impact on the stock price. Shares of SBUX fell more than 30% in 2007. Chipotle's growth strategy could have the same chilling effect on its euphoric stock price.

Chipotle has also earned brand loyalty by focusing on fresh, high-quality ingredients, especially non-genetically modified (GMO) produce. That's all well and good -- but if you've ever shopped in the organic section of your local supermarket, you may have noticed a big price difference. Multiply that on a wholesale level across Chipotle's nearly 1,500 stores. A bump in input cost on Chipotle's end will be passed immediately to consumers. The average ticket for a family of four at Chipotle is already north of $30; how much more would customers pay for fancy fast food, especially in a fragile economy? A price hike of 10% to 15% would definitely slow down traffic.

Hedge fund funny business

One other factor that could contribute to a Chipotle correction could be a last-ditch play by underperforming hedge fund managers. With roughly two months left in 2013, and hedge fund returns averaging 3.4% compared with the S&P 500 Index's 20%-plus, managers are looking for a profitable trade. A stock that has been bid up 80% this year is a prime short candidate. Any hint of bad news will sound the charge for the shorts. Any investors wanting to take year-end profits should see this as an ideal opportunity to pile on.

From a technical standpoint, the stock is putting in the second shoulder of a textbook double top.
That usually spells trouble. After a parabolic run this month, the stock price will most likely take a breather. However, if the fundamentals of the company deteriorate as well, the technical picture will deteriorate exponentially. Shares could fall 50% over a two-year period from their current $500-plus level to around $250 -- which still might be too expensive.

Risks to consider: Whenever taking the bearish side of any investment thesis, there's a chance you could be wrong. Do NOT short stocks if you have no experience doing so. One way to play the decline in a stock price is to own put options. My thesis is based on what I see as investor overoptimism. Remember the old John Maynard Keynes axiom: "The market can stay irrational longer than you can remain solvent."

Action to take:
Investors long shares of Chipotle should take profits if possible. Stop-loss orders are highly recommended. Call options are also a great way to hedge positions and generate income. Those considering buying should avoid purchasing. If you are looking for exposure to the restaurant sector, Darden Restaurants makes more sense at around $51 per share with a forward P/E of 17 and a 4.3% dividend yield.

Adam Fischbaum does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of SBUX in one or more of its “real money” portfolios.

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21Comments
Oct 25, 2013 8:16PM
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Let's see is it ARM, Google, Netflix or Tesla? Oh no it's Chipotle Mexican Grill the McDonald's of Burritos.
Oct 26, 2013 7:48AM
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That's not what the chart tells me. The chart tells me it broke out on heavy volume and a nice Q3  to new highs. Indeed it may pull back, but ride the wave up with a stop loss is how to play this stock. Havasu46, that's what I thought too when I saw the headline, is it NFLX or TSLA?
Oct 26, 2013 2:08AM
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Let's get all the shortsellers on board to fuel the next runup. Double top? The 1st top is at 450 and the 2nd one is at 525, so how is that a double top? That's a bit inaccurate, wouldn't you say? Another piece of dumb article about investing....unbelievable.

Oct 26, 2013 1:17PM
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Have you actually been inside a Chipotle recently? Any day at noon, the lines are 10 rows deep, the 3 counter people running like actual free-range chickens trying to feed all these people that appeared out of nowhere. If you have a little longer for your lunch hour, you'd get in line too, but these days there are plenty of other places you can go where lines are empty. This is one instance where expansion makes sense.
Oct 27, 2013 12:05PM
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I think this stock still has a lot of legs.

 

Signed,

 

Krispy Kreme

Boston Markets

Oct 26, 2013 12:25AM
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I will admit I agree with the author's final conclusion that the stock is over-valued however for different reasons that he stated.  For one, PE alone isn't a good determinant on whether a fast growing company is over-valued or not.  I prefer PEG to PE and from that standpoint the stock looks over-valued to me since the growth is around 20% on the top line.  Valuations for companies with a P/E of 52 CAN be that lofty and be sustainable however the growth has to follow and in this case it's simply not there to justify the price.  A prime example is AMZN which has always been insanely overvalued however the growth has just about always been there to keep up with the valuation.  From a qualitative standpoint there's no telling how families might react.  You would think people would be rational and not pay a lot of money for -in my opinion fresh but overpriced Mexican food at Chipotle- but I've learned to never underestimate people's loyalty to a product.  Apple thrived during the recession making products that were perceived to be better.  Chipotle makes burritos that are comparable to the average mom & pop Mexican restaurant/grocery store yet costs way more.  As for as hedge funds shorting the stock, yes, it is possible and the short interest as of 10 days ago was about 8% of all outstanding shares which is a somewhat high however it's not insanely high yet.  It sounds like the author is saying a huge increase of shorting may happen by the end of the year however from a year ago it's gone down substantially (according to nasdaq's site the short interest was around 4.1 million shares equal to about 13% assuming no dilution took place) from around a year ago on 10/31/12 to be exact. So yes, a huge amount of shares could be shorted from now til January but I wouldn't count on it.  I don't own any shares and I have no interest in owning any. I think it's a well managed company but I'm not a fan of restaurant stocks.
Oct 26, 2013 11:15PM
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the guy has never been to chipotle.  he is either not very bright, has no culinary awareness or is an orthodox jew who is 100% kosher?  chipotle may surprise you - they are that good.

 

stockscouter 7 and 19 analysts at hold or better ... try the guac!

Oct 26, 2013 2:34AM
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Except.... that's not a double top.  It just broke out of double top resistance at $425 and made new highs on strong volume.  It's a lot easier to pick tops on stocks that are actually in downtrends, this is not one of them for now.
Oct 26, 2013 2:45PM
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Technical analysis is claptrap. Just do your homework.
Oct 26, 2013 3:07PM
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Lets not forget stocks can go up forever with the government printing presses going full tilt. Lots of upside probably left. Market no longer goes down significantly.
Oct 26, 2013 9:43AM
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Watch the 10 year Treasury.  When the Fed loses control and it drifts upward staying past 3%, then this market will be unsustainable.

Oct 26, 2013 1:21PM
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Adam

 

I get your point. I'm more interested in shorting Tesla, but I'm gonna add CMG to my watch list just to keep an eye on it.

 

As I read this, I was thinking that doesn't look like a double top to me. Reading the comments I'm not alone, others noticed as well. Actually that looks like a higher high to me and maybe even a higher low but I'll let the tech types figure it out. All the techie types may argue one way or the other. Me, I have to be careful not to let sentiment rule: I don't like Mexican food, maybe Tacos at home are okay, but I doubt you'll see me going in a Mexican Restaurant.

 

Fundamentally, that's a pretty high price for a company with no dividend and almost 11 times book value and a PE ratio around 60 that sells Mexican food. What are people thinking??? Maybe they ain't! What ever you guys are smoking I'd like some.

 

I'm good with Steak & Potatoes at Outback or Lone Star. Red Lobster is cool, but So. Phila. has too many great Italian Restaurants to bother with a canned menu at Olive Garden. 

 

All in all, I don't buy Restaurant stocks, I've seen to many go down in flames, literally. 

Oct 26, 2013 1:13AM
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http://dailycaller.com/2013/10/25/michelle-obamas-princeton-classmate-is-executive-at-company-that-built-obamacare-website/            Or this nazi run company?
Oct 26, 2013 1:41PM
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Although not a completely formed "double top", remains to be seen..

Although I can follow the higher high idea, breaking through resistance...

Is there not also a "head and shoulders" theory too ??

But well in agreement, with author and a couple/few commenters about stock being overbought, high P/E , unsavory PEG and other factors that could lead to a correction...yes probably time to short for maybe an astute investor..

If it had been me, I would have parceled much to the table by now and moved on.

With recent times many restaurant type stocks have been volatile by season, or other conditions.

Oct 25, 2013 8:35PM
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Seems more logical to take your profits from Google, Amazon, Linked-In, Facebook, Wal-Mart, Exxon Mobil, JP Morgan Chase, Bank of America, Citi, Wells Fargo, Goldman Sachs, Morgan Stanley and every useless business platform that pays deadbeat executives too much and over-worked peons not enough. Let's leave Chipotle alone.

 

Can someone find "Adam Fischbaum" for the rest of us and beat the living crap out of him? Time to stop living a social network existence and work our way back through the zombies to commonsense. BIG has to go.

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