I'm Staying Away Even As JPMorgan Upgrades Chipotle Mexican Grill, Inc.

  • JP Morgan gave a surprisingly positive upgrade to Chipotle stock.
  • Entering the burger market and recovering their core business leaves too much uncertainty about the future of the company to get excited.
  • Their share buybacks are a very questionable strategy given their new business ventures.

Although Chipotle Mexican Grill (NYSE:CMG) had suffered from the outbreaks of E coli and norovirus last year, JPMorgan has come out with a positive upgrade on the company stating that they believe earnings will nearly double in 2017 and continue normal growth in 2018. The upgrade seems overly optimistic given the level of uncertainty around whether the company will fully recover from the E coli outbreak and whether it can successfully lift off their new burger chain, among other questions.

CMG-stock-chart

Better Burger

Chipotle has already established two chains they hope to grow; the Southeast Asian fusion food chain, ShopHouse and the wood-fired pizza, Pizzeria Locale. Now they have their eyes set on a burger chain, which they registered for the trade as “Better Burger.” While the burger market is far bigger in size than the Mexican food market, the competition is fierce and can make it very difficult for newcomers to scale, therefore there is no reason to get excited over this yet.

Shake Shack (NYSE:SHAK) is one of the younger burger companies that has been able to scale at a solid growth rate. They are still young and going through some growth pains, and some analysts would claim that they are trading at a premium at 7.3X sales. However, they only have a market cap of $1.4 billion. Given Chipotle's resources, they should be able to assist their new burger chain in fostering significant growth. However, that doesn't mean the concept will work. But if it did, and they had the success of Shake Shack, their new venture would only be worth about $1.4 billion 4-8 years out in a positive public comparable. To assume this new burger venture could grow to $15+ billion and outshine the existing Chipotle chain is far from reasonable. Therefore, there is very little to motivate investors about the company’s new burger chain right now.

High Price And Questionable Strategy

Chipotle is financially sound and that is made clear by looking at their balance sheet – no debt, good liquidity. However, we can expect some debt to be added in the future to help fund the growth of the core business and fund their newer projects. For now, the company is producing fair margins from their operations considering their growth rate and their recent hurdles. The problem is that they are trading at a PE of 31. While that multiple is certainly not high for their past growth, it is high given the sudden relaxed growth and uncertainty about future growth of their core business.

Now while they have a strong balance sheet, the burger venture could cost a lot of money to scale. This is interesting as the company has done significant buybacks, and now they will need that capital to fund future cap-ex. I believe this can be a big error by the management and prove to be a move that could hurt shareholder value. Whether they fund it through debt or equity, it is likely to damage Chipotle’s value of equity. If corporate development plans were in place, then the share buybacks should have been deferred.

Conclusion

At a time when Chipotle should be focusing on the recovery of their core business, they are moving into the competitive burger market. At a time when they should have been focused on having proper capital and liquidity to fund their new corporate development project and grow their core business, they did share buybacks. These kinds of moves make me question management’s strategy, and given the uncertainty of Chipotle’s future, I’d stay away from this one until some more positive developments surface.

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