Key Takeaways:
· Chipotle’s internal growth is slowing.
· Chipotle’s ShopHouse concept is expanding, but we think it could divert attention from the core business.
· We could open a bearish position in Chipotle in the portfolio of our Best Ideas Newsletter.
After its price finally came down to earth in late 2012 (falling to under $250 from over $400 per share), shares of quick-serve burrito restaurant Chipotle (click ticker for report: ) have rocketed back toward the $400 level. Shares have jumped 23% year-to-date, even though the company’s same-store sales growth totaled just 1% in the first quarter. Shares now trade at a premium to our fair value ($338 per share is the high end of our fair value range).
With comparable store sales growth slowing, Chipotle most rely on new-restaurant expansion to drive revenue growth. Luckily, increasing the store count hasn’t been an issue thus far, and the firm remains on track to open 160-180 new restaurants this year alone. Still, total revenue increased just 13.4% year-over-year during the first quarter, and it appears as though the company’s revenue growth rate will fall to the mid-teens during 2013.
Source: Chipotle
Other cracks are beginning to form in the Chipotle story. Fierce competition from Taco Bell (click ticker for report: ) appears to be slowing Chipotle’s pace of market-share expansion. With lower-priced substitutes available, we do not believe Chipotle has much room to raise prices—which should further stall same-store sales growth and limit margin expansion. Additionally, we believe the incremental sales growth from new store openings will begin to cannibalize existing locations (decreasing the marginal benefits of new stores to the firm’s top and bottom lines).
ShopHouse begins to expand…
Enter ShopHouse, Chipotle’s take on Southeastern Asian cuisine. The company’s current location in Washington, D.C. will be joined by two new stores in California over the summer, as well as a location in D.C.’s Georgetown neighborhood. The concept receives mostly positive reviews thus far (according to Yelp), and as we can tell from the image below, it is Chipotle-inspired.
Source: Nation’s Restaurant News
Not surprisingly, the concept has started out slow, as we think it should: we’d be disappointed in a large nationwide rollout of a concept that consumers aren’t crazy about. If Ron Johnson tested his JC Penney (click ticker for reports: ) changes, he might still have a job. From what we’ve gathered, we think the concept could be a hit. At the moment, there isn’t much healthy Asian-inspired fast-food available in the United States, so ShopHouse fills a void in the marketplace.
The expansion isn’t a slam-dunk…
Even though we like the idea, we do not believe the concept justifies Chipotle’s premium valuation. For one, the restaurant is still in its very early stages. The potential for blockbuster success is there, but fast-food is a crowded, uber-competitive space. And it’s certainly feasible that ShopHouse’s market potential could be significantly smaller than Chipotle’s market potential.
Additionally, we think Chipotle is fostering a competitor with its ShopHouse concept. Both restaurants will be fighting for middle-class lunch and dinner dollars in the same price-range, with a similar experience. We doubt it will be a zero-sum game, but we think ShopHouse could eat into the core Chipotle business, to a certain degree.
Finally, the logistics of running two separate fast-food restaurants is difficult. Just a few years ago, Chipotle was owned by McDonald’s (click ticker for report: ), which has also owned Boston Market, Aroma Café, Donatos Pizza, and a stake in Pret-A-Manger. McDonald’s divested all of these properties over the years, and it seems that focusing on different concepts can distract from the core business. Of course, Yum! has largely been able to avoid this issue, but it has rid itself of non-core assets in the past few years as well. The very last thing Chipotle’s management team should do is divert too much attention from its cash cow.
Valuentum’s Take
Although we like the ShopHouse concept, we believe it carries several operational risks without the necessary benefit to justify Chipotle’s current valuation. In our view, Chipotle makes a wonderful product, and we assume ShopHouse’s take on Asian is comparably good.
Nevertheless, we can’t help but think the firm’s current valuation looks out-of-whack with fundamentals. Growth is clearly slowing, and the days of 20%+ revenue expansion appear to be over. We are exploring opening a bearish position on Chipotle in the portfolio of our Best Ideas Newsletter.