Last year was a rough one for Chipotle Mexican Grill (NYSE:CMG). Once a nearly bulletproof growth story, a sharp slowdown in traffic and store comps growth expectations took large chunks out of the stock on multiple occasions. Investors are slow to abandon growth stories (at least outside of tech), and these shares enjoyed a 30% rally to close out the year. Consequently, it's not easy to make a value call on the shares today, and investors should be wary of the expectations that traffic growth will accelerate in the second half of the year.

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

Few Surprises for the Final Fourth Quarter Results
Management previously updated guidance about the fourth quarter, so there weren't many surprises left for the actual quarterly report.

Revenue rose 17% for the quarter, with comps up almost 4% and unit growth in excess of 14%. Food costs (particularly protein) continue to be a headwind, climbing 22% for the quarter. That led to a one-and-a-half-point drop in restaurant margins (this industry's version of gross margin) and a nearly three-point drop in the sequential comparison. Operating income still rose 9%, as the company's operating margin fell a bit more than a point.

If It's not Competition, What Is It?
Chipotle management has been pretty stubborn in maintaining that they are not losing traffic to alternative concepts like the Cantina Menu at Yum! Brands' (NYSE:YUM) Taco Bell. Maybe so, but that doesn't change the fact that Taco Bell's U.S. comps were up 5% this past quarter. Likewise, Panera (Nasdaq:PNRA) saw its comps increase more than 5% for the same quarter, so I would argue that there is at least some shift going on at the high end of the quick service restaurant (QSR)/fast-casual business.

SEE: Evaluating A Company's Management

By the same token, Chipotle is doing just fine relative to more established QSR destinations like McDonald's (NYSE:MCD), and Jack In The Box's (Nasdaq:JACK) Qdoba Mexican Grill is showing pretty feeble growth (0.4% comp growth in fiscal Q4 and 2.4% in fiscal 2012). So context matters. It's also worth noting that Chipotle is still small enough (or concentrated enough) geographically that issues like weather can make a difference.

Is a Midyear Price Increase Such a Good Idea?
Management did talk about the possibility of a price increase around midyear. This increase, on the order of 4 to 5%, would be targeted at offsetting the ongoing food cost inflation that the company expects to see.

I'm sympathetic to the idea of preserving margins, but this could be a tricky move. With management expecting pretty soft comps in the first half of 2013, meeting expectations for the full year will require a recovery of comps in the second half. While the performance in the second half of 2012 should make a comp growth recovery incrementally easier, a price hike risks sapping the momentum if Chipotle's customers have decided that Chipotle's price/value balance is just fine where it is. That could be even more relevant given that several other QSR chains have announced plans to begin more heavy advertising of their value menus in the first and second quarters of 2013.

Does Chipotle Need to Think More Like the Competition?
Chipotle has done a very good job of separating itself from the restaurant pack - not only with the type of food it offers, but a model that uses a relatively short list of ingredients to produce a wide variety of offerings (a model that, to be fair, Taco Bell has been using for a long time now).

SEE: Most Affordable Fast Food Chains

That said, I'm not sure being different is always synonymous with being better. Chipotle has frequently under-spent its marketing targets. That hasn't seemed to hurt its U.S. growth much, but management has said sales at its London stores has been disappointing, with substantially lower volumes when compared to North American locations. With brand recognition cited as a contributing factor, maybe Chipotle needs to invest in brand-building.

The Bottom Line
Given a U.S. market that is still under-penetrated and the potential for additional store concepts, I have no problem projecting strong growth for Chipotle. My working assumption is for long-term revenue growth above 10%, and free cash flow growth approaching 20%, as the company increasingly leverages its existing store base. Should the company roll out new concepts more aggressively, I would expect a trade-off between free cash flow margins and revenue (spending more on cap-ex to generate more sales).

Even with 20% free cash flow growth, these shares don't look particularly cheap. I can get to about $300 per share in fair value on that 20% growth assumption, but that's basically where the shares are now. That said, strong growth stories rarely trade at compelling valuations, so investors who can accept the risks that go with growth investing (and potentially overpaying for that growth) could still find something to like in these shares today.

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

Related Articles
  1. Stock Analysis

    3 Resilient Oil Stocks for a Down Market

    Stuck on oil? Take a look at these six stocks—three that present risk vs. three that offer some resiliency.
  2. Economics

    Keep an Eye on These Emerging Economies

    Emerging markets have been hammered lately, but these three countries (and their large and young populations) are worth monitoring.
  3. Stock Analysis

    Is Pepsi (PEP) Still a Safe Bet?

    PepsiCo has long been known as one of the most resilient stocks throughout the broader market. Is this still the case today?
  4. Investing

    The ABCs of Bond ETF Distributions

    How do bond exchange traded fund (ETF) distributions work? It’s a question I get a lot. First, let’s explain what we mean by distributions.
  5. Stock Analysis

    3 Stocks that Are Top Bets for Retirement

    These three stocks are resilient, fundamentally sound and also pay generous dividends.
  6. Investing News

    Are Stocks Cheap Now? Nope. And Here's Why

    Are stocks cheap right now? Be wary of those who are telling you what you want to hear. Here's why.
  7. Investing News

    4 Value Stocks Worth Your Immediate Attention

    Here are four stocks that offer good value and will likely outperform the majority of stocks throughout the broader market over the next several years.
  8. Investing News

    These 3 High-Quality Stocks Are Dividend Royalty

    Here are three resilient, dividend-paying companies that may mitigate some worry in an uncertain investing environment.
  9. Stock Analysis

    An Auto Stock Alternative to Ford and GM

    If you're not sure where Ford and General Motors are going, you might want to look at this auto investment option instead.
  10. Mutual Funds & ETFs

    The 4 Best Buy-and-Hold ETFs

    Explore detailed analyses of the top buy-and-hold exchange traded funds, and learn about their characteristics, statistics and suitability.
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!