Eating is a life necessity. Eating out, as many restaurant establishments have noted in the last two years, is not. Like quick boom and bust diet fads, the era of dining out has come and gone. Cash strapped consumers on fiscal diets are buying groceries to cook at home. And corporations with tightened business account budgets are finding ways to conduct meetings without lavish cuisine costs.
IN PICTURES: 7 Tools Of The Trade
Generally speaking, the restaurant sector is a risky area to invest in right now because the deleveraging of our economy will inevitably kill off many restaurant concepts. Amidst a crowded and ailing industry, Chipotle (NYSE:CMG)(NYSE:CMG-B) managed to become a raging success. But are its glory days over?
The company reported second quarter results that, relative to many fellow chains like Denny's (NYSE:DENN) and Steak n' Shake (NYSE:SNS), appeared impressive. Chipotle's revenue rose 14.1% and management prided itself on reaching record operating margins. But competitors shouldn't be green with envy yet.
The burrito vendor spiced up its top line with a 6.5% hike in menu prices and by opening new stores. Raising prices was also a driving force behind the margin improvement. Like many of its peers, Chipotle struggled to lure in new customers and traffic actually fell 3.5%. As a result, comparable sales rose just 1.7%.
Peeking behind the headline figures presented less than awe-inspiring results. However, Chipotle still has a lot going for itself. Free cash flow grew 158% to $62.9 million. The company's balance sheet now boasts a cash reserve of $208.3 million - more than double the cash it held last year. And management is putting that cash to good work. The company repurchased $95 million, or 1.7 million shares, of class B shares at an average price of $54. Chipotle B shares are currently fetching approximately $78.53 per share.
In addition, management's new marketing initiatives to tout its use of organic ingredients appear promising. The company is committed to increasing consumer awareness of how food is raised in the U.S. and this is certainly a competitive edge Chipotle holds over many of its quick-serve competitors. (For further reading, check out Sinking Your Teeth Into Restaurant Stocks.)
Great Restaurant, Not So Great Investment
Chipotle is a great restaurant concept, but I'm leery about the company as a long-term investment. Selling at 31 times trailing earnings, the company appears dirt cheap compared to its past prices. In the fall of 2007, Chipotle shares sold for nearly 100 times trailing earnings. But ratio contraction is only expected, as growth has significantly moderated. For the past five years, the company averaged 44.4% annual growth; analysts expected the next five years to deliver 21% annual growth. In comparison to competitors like Panera Bread (Nasdaq:PNRA) and Buffalo Wild Wings (Nasdaq:BWLD), Chipotle commands a premium price to earnings ratio.
I fear that Chipotle has already peaked as an investment. Raising menu prices will only buoy revenue for so long, particularly in recessionary times when consumers are desperately searching for bargains. And like many of its peers, I think management got caught up in the overexpansion of its stores. In my opinion, Chipotle's days of rapid growth have come to a close.
Bottom Line - A One Trick Pony?
Admittedly, I tend to cringe when faddish one trick pony stocks embark on a period of deceleration. In certain times, the right management team can strategically keep the momentum going, but in many cases, like the recent drop of Crocs (Nasdaq:CROX), high-flying companies end up crashing to the ground.
I'm not suggesting that Chipotle's demise is drawing near. The company could have a solid future ahead of itself if management can successfully manage the company's brand as it matures. However, I am warning that Chipotle's shares are overvalued given the overall restaurant environment and the fact that it is a crucial make-or-break period for the company in its growth stage.
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