Uncertainty and Transition Hinder Chipotle
We see the narrow-moat firm as undervalued and are modestly decreasing our fair value estimate.
Narrow-moat Chipotle (CMG) heads into 2018 as a company in transition, with its fourth-quarter update offering a few hints of stabilization that were overshadowed by unknowns. On the positive front, comps are expected to come in the 1%-2% range for the first quarter (versus 0.9% in the fourth quarter), and Chipotle will embark on a restaurant remodeling (including a second make-line for digital ordering at many locations) and an employee investment program to resolve customer experience issues. However, these are tempered by the fact that comps have been entirely driven by price increases (implying low-single-digit traffic declines) and more aggressive promotional activity may be required to stimulate traffic in the future.
Management's outlook calling for low-single-digit comps in 2018 strikes us as realistic, with mid-single-digit menu price increases already baked in, but we think first-quarter restaurant margin guidance calling for 16.0%-16.5% (versus 17.7% a year ago) and acknowledgement that 17.5%-18.5% represents a ceiling this year (implying EPS in the $9 range) are concerns. Admittedly, incremental restaurant and employee investments will weigh on margins, but this could signal that our longer-term assumptions of mid-20s restaurant margins and midteens operating margins (below the mid- to high 20s and high teens posted at peak) might be aggressive. It’s also hard to get a clear picture of Chipotle's longer-term strategic vision (including new restaurant prototypes) without knowing who its future CEO will be. Management did not provide a time frame for concluding its search, adding a further layer of uncertainty.
We're planning a modest decrease to our $350 fair value estimate, as a reduction in longer-term margins will be partly offset by time value of money adjustments and a lower effective tax rate (30%-31% in 2018). While we see Chipotle as undervalued, we think a wider margin of safety is required, given the uncertainty inherent in the investment story.
Morningstar Premium Members gain exclusive access to our full analyst reports, including fair value estimates, bull and bear breakdowns, and risk analyses. Not a Premium Member? Get this and other reports immediately when you try Morningstar Premium free for 14 days.
R.J. Hottovy does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.