Investment Thesis
Chipotle Mexican Grill (NYSE:CMG) has seen impressive growth in recent years, but I think this is short-lived. I not only believe their revenue growth relies heavily on increased foot traffic, but (and this is key) also strategic price increases and what I believe to be poor portion control. The company has denied any changes in portion sizes since opening.
While there are other factors that may contribute to this, consumers are beginning to become dissatisfied with portion sizes. Unlike other fast food, Chipotle owns and operates all of their stores, meaning they have greater control over their portion sizing and pricing policies. This control has already been used to grow revenue as Chipotle has implemented four menu price hikes over the past two years.
While Chipotle has managed to maintain profitability through these strategies, I believe the market appears to overvalue their growth potential. The stock trades at a high price-to-earnings (P/E) ratio, reflecting investor expectations that may not be sustainable given that a big part of growth has been from cutting costs and raising prices. With inflation and economic pressures affecting consumer spending, further price increases might not be feasible. In fact, as I mentioned above, consumers are already beginning to push back.
While the market is fairly confident in Chipotle’s future growth, Bill Ackman's Pershing Square has already trimmed their holdings in Chipotle, signaling potential concerns about the stock's valuation.
Although Chipotle has demonstrated strong financial performance through effective pricing and operational strategies, the increasing consumer dissatisfaction and market overvaluation suggest that their stock may be poised for a correction due to the high expectations for strong growth going forward. Therefore, I believe Chipotle is a strong sell.
Background
Chipotle was founded in 1993 by Steve Ells with the vision of serving high-quality, affordable Mexican cuisine. The company experienced significant growth after McDonald's became a major investor in 1998, helping it expand from 16 restaurants to over 500 by 2005. By 2006, Chipotle went public, marking one of the most successful IPOs in U.S. history at that time.
The company has continued its growth trajectory over the years. As of 2024, Chipotle operates over 3,400 restaurants across the United States, Canada, the United Kingdom, France, and Germany. In 2013, Chipotle's revenue was $3.2 billion, which increased to $8.63 billion by 2022 and by 2023, Chipotle had achieved a revenue of $9.9 billion, a 14.3% increase from the previous year.
While their revenue growth continues to be promising to investors, my outlook on this company has become bearish. I believe their methods for revenue growth will eventually slow as consumers push back and shift to other competitors.
Consumers Are Pushing Back
Chipotle is facing significant consumer backlash due to several controversial changes in their pricing and what I, personally, believe to be are poor portion strategies.
On social media platforms, many users have expressed their dissatisfaction, with some even initiating the "walkout method" where they leave the store mid-order if they (the consumer) feel the portions are insufficient. This movement highlights a growing discontent among Chipotle's customer base over what they perceive as diminished value for their money. This walk-out method began after food critic Keith Lee expressed his dissatisfaction with Chipotle’s quality and portions sizes.
It is undeniable that Chipotle has been increasing serving prices. One major point of contention has been Chipotle's decision to charge extra for items that were previously complimentary or cheaper, such as the "tortilla on the side." This change blindsided many loyal customers, leading to a sense of betrayal and a surge of negative feedback on social media. When looking at overall prices, Chipotle's prices have increased significantly over the past decade, rising by about 75% since 2014. This is more than double the national rate of inflation, making the once affordable meals much more expensive for the average consumer.
Chipotle Could Face Competition
As a result of backlash regarding price hikes, I believe it is likely we will see consumers take their business elsewhere. The three companies that jump out at me most are Qdoba, CAVA (CAVA), and Sweetgreen (SG).
Cava was founded in 2006, opening their first location in 2011. In June of 2023, Cava made their market debut as a publicly traded company, resulting in a 117% share price increase. As of May 2024, Cava currently has 323 locations nationwide, opening 72 locations in 2023. Keeping with this trend, they aim for at least 15% growth in 2024 and 2025, and 1,000 locations open by 2032. While Cava is a relatively small company compared to Chipotle, their revenue growth in the last year was far better. From December 2022 to 2023, Chipotle saw a 13.61% increase in revenue, while Cava saw a 29.17% increase. As I mentioned above, Cava has only recently become a public traded company. Looking into Chipotle’s past, they became publicly traded in January of 2006. Within their first year of being a public company, they saw revenue increase by nearly 32%, only slightly more than Cava.
Sweetgreen, which was founded in 2007, and became a publicly traded company in 2021, has opened 221 locations across the United States as of December 2023. When comparing their revenue, as mentioned above, in the last fiscal year Chipotle has seen an increase of 14.33% in revenue, while Sweetgreen has seen an increase of 25.23%.
While both of these companies are fairly new, I believe both have the potential to be a real competition to Chipotle. In fact, some critics have begun to compare Cava and Chipotle. I predict the same will occur for Sweetgreen as consumer dissatisfaction with Chipotle grows. When putting the Cava and Chipotle side by side, Cava seems to take the lead in these critics' eyes.
Shifting to Qdoba, Qdoba has been a long-time competitor of Chipotle. Their menus are practically the same, but Qdoba is cheaper. When ordering at Chipotle, some toppings are an add-on cost, such as guacamole and queso, but at Qdoba, they are free. The average Chipotle costs roughly $15, a big step up from 10 years ago (2014).
Valuation
As I mentioned above, my core reason for my strong sell thesis is that I believe Chipotle’s revenue growth is unsustainable, and the market is severely overvaluing this company. When looking at their valuation metrics, Chipotle’s Non-GAAP P/E (FWD) ratio is 56.74 which is 257.47% higher than the sector median of 15.87. This compares to the EPS forward long-term growth (3-5 year CAGR) which comes in at 20.83%. This is 81.69% higher than the sector median. It does not make sense to me to pay a 257.47% premium over the sector median valuation when you only get access to growth that is 81.69% higher than the sector median.
While I believe Chipotle is overvalued, I will not deny their strong performance. In the last year, Chipotle saw $9.87 billion in revenue, and is predicted to reach at least $11.36 billion in 2024. Therefore, I do not believe we will see their P/E dip below the sector median, but rather just see a correction.
Previously, I stated that their revenue so far has been driven by not only increased foot traffic, but also price increases and what I believe to be poor portions. With this in mind, I do not believe the predicted revenue for Chipotle is sustainable because these methods will eventually lead to a breaking point for consumers (which I think we are near). Considering that Chipotle has already experienced some backlash from their customers, I do not see these methods lasting much longer for them.
Given this, I think the stock could see some downside. For example, if we had a forward P/E ratio on Chipotle that was 81.69% higher than the sector median, this would be a forward P/E ratio of 28.83. If Chipotle stock re-rated to this lower P/E ratio, this would represent 49.18% downside from today’s share price.
Bull Thesis
One of the primary risks to my strong sell thesis is the potential for Chipotle to split their stock. As of today, their stock price is $3,141.95, but in April of this year a 50-1 stock split was proposed. Although this has not been approved yet, shareholders are set to vote on June 6th. If this were to occur, this would open the company to a wider range of investors, allowing more to buy the stock due to the cheaper per-share price (but not cheaper from a valuation perspective).
Another reason to be potentially bullish is the younger generations' consumer loyalty. According to Chipotle, over half of their customers are Gen Z or Millennials. This is great for Chipotle because according to consumer behavior studies, “70% of millennials (9% more than the average consumer) will go out of their way to buy from their trusted brand.”
With a large portion of their consumers coming from younger generations, it is likely that many consumers will continue to purchase from Chipotle despite being dissatisfied. However, for my thesis to work out, I’m not arguing for demand to drop 60% or anything crazy. Rather, I am simply saying that their forward P/E is so high that all that, I believe, needs to happen is that if the market sees revenue and EPS growth slow, this could cause investors to quickly rerate the stock to a lower P/E even if demand doesn’t necessarily slump.
Takeaway
While Chipotle has shown impressive growth, I believe their revenue growth strategies appear to be reaching their limits. The company’s revenue growth, to which, I believe, is heavily reliant on increased prices and increased foot traffic, has sparked consumer dissatisfaction. This is evident from the backlash on social media, where movements like the "walkout method" demonstrate growing discontent over perceived declines in value. As consumer dissatisfaction increases, I believe competition from companies like Cava, Qdoba, and Sweetgreen, will have a larger effect on Chipotle.
While the market remains optimistic about Chipotle’s growth, the high price-to-earnings (P/E) ratio leads me to believe the stock is overvalued. I believe unless Chipotle addresses the underlying issues of consumer dissatisfaction, their current growth trajectory may not be sustainable. Therefore, considering these factors, Chipotle’s stock may be poised for a downside risk, leading me to believe the stock is a strong sell.
Noah's Arc Capital Management
This account is managed by Noah's Arc Capital Management. Our goal is provide Wall Street level insights to main street investors. Our research focus is mainly on 20th century stocks (old economy) undergoing a 21st century transformation, but occasionally we'll write on companies that help transform 20th century firms as well. We look for innovations in a business model that will cause a stock to change dramatically. Associated with SA contributors Thomas Potter and Elijah Buell.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of SG either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Noah Cox (account author) is the managing partner of Noah’s Arc Capital Management. His views in this article are not necessarily reflective of the firms. Nothing contained in this note is intended as investment advice. It is solely for informational purposes. Invest at your own risk.
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