Chipotle short squeeze puts shares 50% above valuation of peers – chipotle mexican grill, inc. (nyse cmg) seeking alpha electricity grid australia


Chipotle Mexican Grill ( CMG) has short sellers scrambling this week after the company reported a 2% same store sales increase for the first quarter, and saw margins boosted by a 5% price increase and a cutback in marketing spending. With the stock up 25% post report, the shares now trade at about 2.4 times enterprise value-to-revenue using 2018 projections. If that sounds high, especially for a chain that’s still seeing customer traffic counts fall by 3% year-over-year, that is because it is very high, compared with other chains.

We decided to put together a list of comparable companies to illustrate exactly how expensive CMG shares are right now. Such an exercise is actually harder than one might think, mainly due to the fact that Chipotle is a very large, 100% owned and operated fast casual chain, and those are rare. Dining concepts tend to start out as company-run, to establish the brand, and then choose to grow by franchising anywhere from 25% to 50% of locations. Doing so allows for nationwide growth without as much capital investment from the company, as franchisees pitch in for the build out. In fact, we were unable to find any publicly traded fast casual chain with 500 or more units that’s 100% owned and operated (no franchised locations).

In order to make a list of comps for CMG, we decided to include smaller chains, chains that offer table service, as well as large chains that franchise up to 20% of their locations. Such looser rules were the only way to come up with a list of comparables. The resulting list helps shed some light on just how expensive Chipotle stock is relative to other national players.

In order to be able to compare valuations, we are using the enterprise value to revenue metric, which allows for adjustments for balance sheet health. Chipotle, for example, has more than $500 million of cash on their balance sheet, and no debt, so that needs to be accounted for in the valuation comparison. We also made sure to include operating margins for each chain, because two chains with the same revenue do not necessarily deserve the same valuation, if they do not earn similar margins on each dollar of sales.

After combing through the list of all public restaurant businesses, the final cut consists of Bloomin Brands ( BLMN), Darden ( DRI), Cracker Barrel ( CBRL), Red Robin Gourmet Burgers ( RRGB), Texas Roadhouse ( TXRH), Potbelly ( PBPB), and Habit Burger Grill ( HABT).

The list may look overly diverse at first blush, but it actually is not easy to find publicly traded chains that own at least 80% of their locations and have hundreds, if not thousands, of units already open. In fact, excluding chains with sit down service would have rendered the comparison even harder, as the only two fast casual stocks that fit that mold (HABT and PBPB) are much, much smaller than Chipotle.

There are two main takeaways from this table in our view: 1) Wall Street is correctly basing their EV/sales multiples on underlying profit margins in most cases, and 2) Chipotle is really the only company on this list where the numbers appear to be inconsistent with the industry.

Even if CMG had industry leading profit margins, which was the case when they were a smaller chain with less competition, it should probably still trade for well less than two times EV/sales. And yet, here we sit today and the company fetches a 50% premium to the leading owners of restaurants (DRI and TXRH), even though they have less runway for growth (as the biggest chain already) and are experiencing traffic declines thanks to massive competition and location cannibalization (over 100 new units being opened every year).