This high-flying stock could tumble 50%
After a spectacular run, it's time to take profits in Chipotle Mexican Grill. Here's why.
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.
StreetAuthority LLC owns shares of SBUX in one or more of its “real money” portfolios.
More from StreetAuthority
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.
I think this stock still has a lot of legs.
Watch the 10 year Treasury. When the Fed loses control and it drifts upward staying past 3%, then this market will be unsustainable.
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.
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.
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.
Copyright © 2014 Microsoft. All rights reserved.
Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.
New legislation is allowing foreign companies to finally invest in the country's vast oil reserves.
VIDEO ON MSN MONEY
Top Stocks provides analysis about the most noteworthy stocks in the market each day, combining some of the best content from around the MSN Money site and the rest of the Web.
Contributors include professional investors and journalists affiliated with MSN Money.
Follow us on Twitter @topstocksmsn.