Is Growth on Chipotle's Menu?

Source: Chipotle | Twitter

Finding a good growth story and trying to make a case for why it belongs in a value investor's portfolio has always been difficult.

There's the excitement of growth, but more often than not, that growth comes at an expensive premium, and there are no guarantees the company will ever grow into that valuation.

This summarizes my relationship with Chipotle Mexican Grill, a stock I've always wanted to like but just can't. Add recent concerns about margin pressure and slowing comparable, and the stock becomes even less appealing.

The food is delicious, yes. But owning the stock requires a strong stomach. The company posted a 17 percent year-over-year increase in revenue, but it arrived flat sequentially. If you really want to get technical, there was actually a 0.20 percent drop from the third quarter. It may be splitting hairs but it's an example of how the optimism in this stock—based on strong growth—seems overdone.

The company posted just 3.8 percent growth in comps at the end of 2012. This is the metric that tracks the performance of restaurants opened at least one year. While that is on par with the 5 percent posted by Yum Brands and the 3.1 percent posted by McDonald's, this comp number is still an example of what has been a disastrous year for Chipotle.

Consider that its comps were at 11.1 percent in 2011 when the stock began trading around $360 in January 2012. However, comps dropped to 8 percent in the second quarter, and then to 4.8 percent in the third quarter before ending the year at that 3.8 percent figure. That the price-to-earnings ratio is twice the valuation of McDonald's (36 vs. 18) implies investors are still betting big that Chipotle can turn things around.

But this quarter didn't prove anything other than to suggest Chipotle is still in trouble.

Where's the Growth?

Without answering this question, it's tough to make a case why anyone would go long on this stock at current levels, especially after the recent volatility. Granted, Chipotle's business concept—using local, fresh ingredients for many dishes prepared in an open kitchen, according to the company—is still being embraced by diners. That's the only reason management would invest so heavily in expansion to the extent of saying it planned to open 165 to 180 restaurants this year.

However, this is not the same bulletproof company that once had the Street believing valuation didn't matter. The Street now seems schizophrenic in how it wants to appraise the business, which has also impacted upon the stock.

There is no sign the rising cost of food, up 22 percent in the quarter, is going to slow. This is one of the reasons why rivals including McDonald's have begun to adjust menu items and prices.

Although Chipotle said that it plans to raise the prices on its menu, this may have an adverse effect in a challenged economy. Chipotle showed better cost management to offset the rising cost of beef, but the company still has to answer that important question: Where's the growth to come from this year and beyond?

While commenting on the company's results, Steve Ells, Chipotle's chairman and CEO, mentioned (among other things) the company may consider catering at some point this year. Catering sounds "different," but without knowing the associated costs it's tough to get bullish on the concept.

I'm not certain this will have much of an impact in the near term. Investors who are paying for growth today want assurances that margin and comps will begin to move in the right direction again.

Unfortunately, management only guided for flat to low-single-digit comps for all of 2013. While Chipotle prides itself on being different, I'm not so certain that it is. Yum's Taco Bell has a similar business model and so does Qdoba Mexican Grill, which is owned by Jack In The Box. The latter is struggling to compete and posted just 2.4 percent growth in comps for fiscal 2012.

Bottom Line

From the standpoint of Chipotle's being different, I haven't been able to tell. Chipotle is seen as a "new concept," but it really isn't. Taco Bell has been doing the same thing for years.

Perhaps Chipotle management believes catering will make the difference. Raise your hand if you've never heard of catering before.

Chipotle needs to be more forthright about the competition, and investors need to be more realistic about expectations.

By Contributor Richard Saintvilus

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