Chipotle Mexican Grill Inc. (NYSE: CMG) made its name in the crowded fast-food industry by boasting its use of simple, unprocessed ingredients through supporting responsible farming and advocating for food integrity. The strategy has worked well for the company when it comes to attracting customers. Any food service should be about the food quality customers receive and the service image perceived by customers. In Chipotle's case, fresh ingredients and meats from animals raised to roam free do taste better; the company's image talk is backed up by what it can do with food quality.
Investors have always had high growth expectations for Chipotle because of a seamless convergence of the company's image and the quality of the food it serves. They believed that the company could sweep the market through continued store expansions and sustainable same-store sales growth. Chipotle has largely done that with productive yearly growth and a fertile profit margin. However, expectations may have gone too far ahead of the business reality as it takes time to build a retail reach. Market valuation of Chipotle stock was at times stratospheric, making it vulnerable to volatility when the perception of the company suddenly changed.
Sales Growth Rate
Standing out among food-service providers is almost a guarantee to continued sales growth for Chipotle. From 2011 through 2014, the company grew its annual sales consecutively at an average rate of 22%. In 2015, revenue continued to rise quarterly for the first three quarters. Even with the food contamination news breaking out in August, Chipotle still finished that quarter with more sales, though at a much slower growth rate. The company is likely to show another year of sales growth in 2015 when fourth-quarter results become available. Chipotle's 22% sales growth rate dwarfs the 1.84% rate for its peers and the 4.18% average rate for the industry. Even as it tries to reassure customers of its food safety, Chipotle can still expect some growth, however small it may be.
Chipotle maintained a steady, healthy operating margin of between 15 and 17% for the five-year period from 2010 to 2014. Coming into 2015, operating margin has inched even higher to 19% based on available financial data for the first three quarters. Positive earnings growth has also fueled the rise of Chipotle stock. However, as investigations into the company's food contamination incidents continue, it is possible that the company may get hit with fees and fines in retribution and penalty. Such charges can take a bite out of the profit margin and with down earnings, Chipotle stock may see further downward adjustments.
At the height of Chipotle stock's trading on Aug. 5, 2015, and based on the then-trailing 12-month earnings data, the stock had a price-earnings (P/E) ratio of more than 45, which was much higher compared to the market average. As of Jan. 28, 2016, the stock still commands a P/E ratio north of 26 based on earnings data for the 12 months ending Sept. 30, 2015. The decrease in the stock's P/E ratio resulted from a 40% decline in the stock's price from its all-time high. However, at its current valuation level, the stock's market capitalization is close to six times the company's total equity book value, an indication of premium valuation.
The recent food contamination issues at Chipotle have played into the stock's downfall with a damaged image in the backdrop, and it probably will hit the company's sales and profit margin in the short run. Over time, Chipotle can restore its image and recover from the financial losses. Investors should probably value Chipotle stock more realistically.