I wrote two months ago that I would write an article about my Chipotle (CMG) stock purchase. I have slacked off on this post until now, so here it is!
I don’t want you to think this is an endorsement for everyone to out and buy stock in Chipotle; my goal is to show you how I approach investing. As you will see, I approach investing in company stock just as if it were a company – this is because, well, it is a company! A company that produces a product and has sales and revenue and stores and assets.
I wrote my investment thesis almost exactly one year ago on June 6th, 2016. At the time, Chipotle was trading at $433.94. I didn’t purchase the company stock until it was under $410. My cost basis for Chipotle is $408.83. As of writing this, the price of Chipotle is $462 per share and I have a gain of 12.73%.
*My cost basis is different from my portfolio page. My portfolio page includes my stocks as of the first of 2017 in order to create a uniform start point for my stocks for tracking.
So here it is, my investment thesis in Chipotle.
Investment Thesis for Chipotle
Written June 07, 2016
Price – $433.94 / Share
Market Cap – $12,671,048,000
Target Price – $475 – $540
Shares Outstanding – 29,200,000
2015 Earnings – $475,602,000 (15.10 EPS Diluted)
EV/EBIT (Unadjusted) = 24.55
ROIC (Unadjusted) = – 15.6% 1st Quarter (45.1% average of past four quarters)
PE (Unadjusted) = 43.1
Price/Book = 8.5
Valuation (based on 10 years into the future):
Chipotle (CMG) was heavily overvalued until recently. The price of the company has decreased drastically due to the foodborne illness outbreak in 2015. I believe in two years, the current and future customers of Chipotle will have little to no negative stigma remaining from the company’s foodborne illness problems of 2015. Similar companies that have had food illness problems have recovered within around two years. The company has handled the situation exceptionally and has taken proper actions to protect their brand through campaigns for free burritos to the public and other deals keeping foot traffic in their stores. I do believe that over the next year the profitability of the company will be temporarily depressed due to the foodborne illness problems, but that sales will increase in the near term.
The company’s stock is valued at a PE of 43.1x, but this is not an indicator of the real PE ratio. The stock is temporarily depressed and if the company were trading at the same market cap next year, I believe it will be closer to a multiple of 30x. This is below its average PE multiple of 50 over the past five years.
In my opinion, I have been conservative in my estimates. The company has been expected to open up to 235 new stores in 2016, and expects to open approximately 2000 more new stores in the US alone over time. My conservative assumption include growth of 150 new stores per year over the next ten years. I believe that is more than possible even if fixed costs increase slightly and margins decrease slightly.
The overseas potential for Chipotle is also not built into this valuation; the overseas potential for the company is substantial. On Wednesday June 1st, 2016, I went to the Chipotle Paris, France, La Defense location at 1:30 pm where there were 26 people waiting in line. This strikes me as a prime example of the expansion potential overseas. Overseas potential is one of the reasons I see Chipotle as a compounder with potential far into the future. I don’t think they will be done when they hit 2000 more domestic stores.
With the stock currently trading at $433 / share, with a conservative estimate, the stock is worth $477 / share. I believe this to be on the low end of the spectrum and the real potential for the stock to be closer to $540 per share. This is also not a cigar butt, but a compounder. This company has the potential to continue compounding high rates of return ten – twenty years or more into the future.
- Growth Rate assumed is for same store sales is 4% vs. a much higher historical growth.
- Assume 150 new store openings vs. a plan to open 235 new stores in 2016 and likely average 200 new stores going forward.
- My valuation of the present value of the current stores uses 2008 stores vs current stores of 2066 (as of the March 31st 2016 58 opened that quarter).
- Used a 40% corporate tax rate to calculate current store sales and new store openings vs approximate 38% current tax rate.
- Calculated after tax per store profit to be $372,154 but used a more conservative profit per store of $339,000. (Partly to offset the reduction in profit due to foodborne illness problems)
- I did not include share buybacks (in first quarter 2016 the company bought back 1.2 million shares)
- I did not build in overseas restaurant openings.
- I was conservative with the present value of the company’s book value.
- My valuation is based ten years into the future and I didn’t use any terminal growth in my assumptions as I will revalue each year ten years into the future.
- I assumed each new store has no profit until the end of year three.
- I only assumed 3% same store sales growth within existing stores and a 8% discount
- I assumed 0% same store sales growth over time with the new stores and a 15% discount rate due to the uncertainty of how many new stores can be opened over time.
- Increase sentiment toward the brand as time heals the food-borne illness problems.
- High cash flow to reinvest in extremely profitable stores with high ROI within two years
- Overseas expansion potential
- Organic growth by adding new menu items
- Food with a purpose initiative are where the public are moving
- Brand suffers further disintegration due to potential future food-borne illness outbreaks
- The public takes longer to disremember the food-borne illness problem in 2015
- The brand could be materially tarnished by the food-borne illness problem.
- The company could experience a reduction in their margins and an increase in fixed costs due to new food control protocols. This could hurt cash flow and have an effect on how many stores can be opened in the future.
I hope this helps some of you think about the actual business economics of the stocks you buy. Instead of listening to the talking heads on the news, or short sided analysts, you can come to your own conclusions.
Not all analysts are created equal. The analysis done by many Wall Street analysts is thorough and worth reading. However, the conclusion many of those analysts come to is another story.
Unfortunately, a long term horizon for many analysts on Wall Street is about 2 years. If you don’t care about what happened in 2 years, but in 5 – 10+ years, why do you listen to the analysts?
Do your own thinking about the company as an actual business with specific economics. If you can figure out the economics of the business, you can figure out what range you think the stock should sell for. If you figure out what the stock should sell for, you can solve the puzzle of whether it is undervalued or not.
Thanks for reading and I hope this helps all of those interested in buying individual stocks!
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Disclaimer: These are the ideas and opinions of the author. The author is not responsible for the actions of those who read the posts on this blog. Each individual reader has a unique situation and unique needs. This blog is not intended to solve those unique situations of the readers. This blog is not liable for decisions made by the readers of this blog.
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