Although the dining industry is not exactly a high-growth industry in the traditional sense, investors have seen repeatedly that the right concept, bought at the right time, can deliver substantial capital gains. Chains such as Red Robin (Nasdaq:RRGB), Cheesecake Factory (Nasdaq:CAKE), Buffalo Wild Wings (Nasdaq:BWLD) and Panera (Nasdaq:PNRA) (and before Panera, its predecessor Au Bon Pain) have all had their runs, but maybe none quite like Chipotle Mexican Grill (NYSE:CMG).

Unfortunately for investors, many seemed to fall into the common trap that valuations didn't matter and Chipotle would always outgrow such tiresome concerns as valuation. With same store sales slowing significantly this year, the stock has tumbled on worries about that growth-value trade-off. While the valuation at Chipotle is as reasonable as it has been in some time, it's still not exactly cheap unless investors believe this company can essentially break the rules when it comes to future growth.

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Third Quarter Results Not Really So Terrible
Based on early trading Friday morning, Wall Street seems to be overreacting to third quarter results from Chipotle that weren't really that terrible. Yes, the company came up a little short on margins, but traffic is holding up better than feared, and management's conservative reputation suggests that next year's guidance may be understated.

Revenue rose 18% this quarter as Chipotle continues to open new stores at an aggressive pace. Same-store sales, though, rose just 4.8% - down sharply from 8% in the second quarter and 11.3% last year. This number was a little better than I had feared, but a little light of most sell-side expectations - traffic actually improved over the second quarter to 4.2%, but negative mix shift pressured pricing.

Restaurant-level margins improved 70 basis points to 27.4% - a strong result for any normal restaurant, but a little shy of expectations. Consequently, operating income of 20% wasn't quite good enough.

SEE: Analyzing Operating Margins

Mind the Traffic...and Wonder Where It's Going
I suspect that it's Chipotle's guidance that is fueling most of the sell-off this morning, as management's guidance for full-year mid-single digit comps could include negative comps for the fourth quarter, which I don't believe has ever happened in the company's history. Equally concerning, management was talking about "flat to low-single digit" comps for 2013 - quashing hopes for a significant near-term growth recovery.

So, what's going at Chipotle? Management continues to maintain that they are not losing business to Yum! Brands' (NYSE:YUM) Taco Bell and their new Cantina menu. Overall, quick service restaurant (QSR) volume isn't really trailing off, though, so those diners are going somewhere. Actually, Chipotle's traffic still looks good relative to the restaurant industry as a whole, but they seem to be gaining less incremental share - perhaps suggesting some momentary saturation, menu fatigue, or price concerns.

It's also worth noting that Chipotle management has, for the most part, been one that under-promises and over-delivers. I wouldn't ignore their caution regarding traffic next year, but I also wouldn't be surprised if they ultimately surpass those numbers.

SEE: How To Decode A Company's Earnings Reports

How Much Growth Can Chipotle Really Deliver?
The central question for establishing a fair value on Chipotle is just how much growth the company can deliver. Right now the company is roughly one-tenth the size of McDonald's (NYSE:MCD), but has yet to saturate the U.S. market, nor expand its concept overseas. On the other hand, the company has likely rolled about about 50% of their sustainable footprint in the U.S.

As the company's store growth decelerates, free cash flow margin should head higher. However, this is where the growth analysis gets tricky. Even if Chipotle can deliver superior free cash flow margins to McDonald's (pretty much the industry leader), a decade of mid-teens revenue growth still only delivers a fair value in the $280s (while 20% compound annual free cash flow growth will push that into the $320s to $330s).

SEE: Free Cash Flow: Free, But Not Always Easy

The Bottom Line
I'm not making a bearish call on Chipotle's ability to take their core concept overseas, nor to create additional successful concepts here and abroad. What I am saying, however, is that even after a big decline in the stock, there's still quite a lot of growth baked into the valuation. Chipotle's demonstrated history as a superior performer validates that to a certain extent, but its premiums to Buffalo Wild Wings and Panera could contract further.

Although the contrarian in me is tempted to step up and buy Chipotle on the thesis that there's plenty of growth to come and better traffic trends will restore investor confidence, I still see downside risk in what is still a very highly valued restaurant stock. Consequently, I find the sidelines to be a safer spot for the time being, realizing that I may well miss another powerful rebound in this stock.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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