Chipotle's Otherworldly Report

Authored By Louis Stevens

In June, I shared that the QSR (quick service restaurant) space had become a "den of unmitigated speculation," in the sense that Chipotle, as one example, traded at its highest valuation in its company history, adjusting for net margins (adjusting for net margins has been and remains an essential component of the thesis, as it is for virtually every growth company. Without belaboring the point, it's nonsense to refer to a growth stock's p/fcf, p/e, or ev/fcf without making some comment on its operating and free cash flow margin trajectories).

The share prices and valuations of Wingstop, CAVA, and Sweetgreen had also entered states of unbridled euphoria in this aforementioned den of unmitigated speculation, and, as of today, there's been some reckoning, or some version to the mean.

CAVA, Sweetgreen, & Wingstop Percent Off Recent Highs (Chipotle Is Not Depicted Below, But It Fell 26% From Its Recent Highs)

I think each of these companies is worth looking into, and LAS' Equity Research has covered CAVA in great depth, dating back to its IPO.

And Chipotle's report yesterday evening reveals why they're so compelling.

Chipotle just reported its best quarter since at least 2014; possibly ever (I understand I am sharing this idea that the companies in LAS' coverage universe have been reporting their best quarters ever recently, and it may sound excessively optimistic, but it's just based on data and it's because these are good businesses. Why would I be considering businesses not improving to such an extent that they report their best quarters ever?).

While LAS has not rated Chipotle, I wanted to delineate the company's valuation framework whereby you can be ready to buy, and I can be ready to rate the business a buy when the time comes.

As of today, LAS has not rated Chipotle a buy nor sell because:

1. Chipotle has been expensive, and I've just been patiently waiting for it to become not so expensive. Note that this expensiveness has always been an "issue" with the stock, but that expensiveness was deceptive for many years following the ecolapocalypse situation of 2015, following which its operating and restaurant level margins collapsed and have been gradually recovering since. In Chipotle's Q2'24 report, its restaurant level margins hit ~30% and its operating margin hit 20%, their highest level since at least 2014. So there's not nearly as much room to adjust margins upward in our valuation calculations such that the stock becomes less expensive on a "true, long term margin potential" basis. The superficial p/e or ev/fcf is now a much more accurate reflection of the value of the business, whereas, it was not in the wake of the ecolapocalypse.
2. The QSR space became a den of unmitigated speculation, and it's always tough to know when speculation of this nature will subside. This is the inherent issue with shorting stocks.

With all of this in mind, below, I shared a brief mathematical articulation of the Chipotle thesis that I shared on X but wanted to store it here for future reference during market sell offs.

Here’s the CMG thesis and framework I shared on X:

The CMG report was otherworldly.

~30% restaurant level margins + 20% operating margins (no debt so no interest expense, 25% effective tax rate) = 15% fcf margin

Chipotle's Free Cash Flow Margin Evolution Last Five Years

15% fcf margin * 3B Q2'24 sales annualized = $1.8B in free cash flow

1.38B shares outstanding * $52/share less $2.4B net cash (no debt) = enterprise value $69B

$69B/$1.8B = 38x EV/fcf (note this is on an annualized basis)

Alongside 18% top line growth (driven by transactions and mix, not price) relentless buy backs, huge cash, no debt, and a brand with effectively no real competitors

What a joy it would be to get swings at $40/share or lower, both for investors and for CMG's buy back program

Continued:

CMG 3.1k locations currently, 7k target in North America (including Canada)

GYG demonstrating concept works in Asia Expansion into

EU underway, expansion in Middle East underway

Basic rice, chicken, beans concept; far more universal than burgers, fried chicken, pizza

Lower share price scenario:

CMG $40/share = 29.8x EV/FCF

Would be a 3.33% yield w/ ~12.5-15% annualized top line growth + sustained buy backs getting fcf/share to 15-20% growth

More the stock falls the more fcf/share growth accelerates

Huge brand moat, pricing power demonstrated last three years

Again, while LAS has not rated Chipotle, this will be the framework for any future ratings, and I wanted to give it you to ahead of time.

Disclosures:

L.A. Stevens has not rated Chipotle.