The Surprising Reason This Good Company Is a Bad Investment

Chipotle Mexican Grill is a great company. The largest fast-casual restaurant in the US, Chipotle has carved out a wide economic moat, thanks in part to industry-leading comparable sales growth and a loyal customer base—and we still think there’s plenty of room to grow. The company suffered a loss in August when former CEO Brian Niccol left to lead Starbucks . Niccol’s departure isn’t why Chipotle is a stock to avoid today, though. The real reason to skip it: We think the stock is significantly overvalued, trading nearly 40% above our fair value estimate. That’s why even though Chipotle lands on Morningstar’s Best Companies to Own list, its stock is among Morningstar chief US market strategist Dave Sekera’s sells in 3 Stocks to Sell and 3 Stocks to Buy in November.

Chipotle’s business strategy rests on five pillars: running successful restaurants, attracting and retaining diverse talent, making the brand visible, relevant, and loved, investing heavily in restaurant tech and innovation, and improving access and convenience for customers. In our view, the company has carved out an enduring niche in the US restaurant landscape, with competitive menu prices, extreme convenience, and “food with integrity” allowing it to lure away customers from both casual dining and traditional fast-food competitors. We see Chipotle as well positioned to meet future customer demands and boasting sufficient pricing power to defray persistent inflationary pressure, if necessary. It continues to invest ahead of the curve, defending its enviable growth runway.

Key Morningstar Metrics for Chipotle

• Fair Value Estimate: $42
• Star Rating: 1 Star
• Economic Moat Rating: Wide
• Uncertainty Rating: Medium

Economic Moat Rating

The restaurant industry is intensely competitive. Nonexistent switching costs and constantly evolving customer demands make it difficult for operators to carve out durable competitive advantages. Firms able to do so generally benefit from some combination of pricing power attributable to an enduring brand intangible asset, strong relationships with master franchise partners, an internationally replicable concept, compelling store-level economics, or scale-driven cost advantages. In our view, Chipotle merits a wide economic moat rating. Its industry-leading comparable sales growth, loyal customer base, and advantaged positioning to meet changing consumer demands are likely to catalyze excess returns through the 20-year horizon implied by our wide moat rating. Average return on invested capital of 36% during our explicit forecast healthily outpaces the firm’s 9% cost of capital.

Read more about Chipotle’s moat rating.

Fair Value Estimate for Chipotle Stock

Our fair value estimate is $42 per share. We view comparable-store sales, new unit openings, and restaurant margins as the most important valuation drivers for Chipotle. We forecast 4.8% average annual comparable sales growth through 2033, comfortably ahead of roughly 3%-3.5% nominal industry growth through the cycle. Our model calls for 9% unit growth through 2033, with the firm leveraging commanding unit economics and strong cash flow generation to push a median run rate of approximately 480 net new stores per year over that period, ahead of the absolute figures in the mid-2010s. We forecast restaurant margin expansion to 31%-32% in 2033 as fixed-cost leverage and automation initiatives bear fruit.

Read more about Chipotle’s fair value estimate.

Risk and Uncertainty

Chipotle is exposed to risks consistent with the rest of our restaurant coverage, including input cost inflation, pressure on consumer wallets, and category competition. Maintaining its success against lofty investor expectations will require nearly flawless execution as the company scales its supply chain, sources new real estate opportunities, and enters new trade areas. Competition for real estate, construction crews, and staff adds a layer of risk to our forecasts. Increased attention to minimum wage growth and worker benefits could pressure results, forcing restaurants to look for ways to keep costs in check by reducing their dependence on labor. However, Chipotle’s strong value positioning and restaurant margins help insulate the firm from the worst of labor market volatility.

Read more about Chipotle’s risk and uncertainty.

Chipotle Bulls Say

• Accelerated digital adoption during the pandemic supercharged Chipotle’s loyalty program, which should continue to drive increased order frequency and reduce customer churn.
• Chipotlanes should position the brand to better compete with quick-service rivals while opening up new trade areas. They’re in 25% of the existing store footprint and 80% of new unit openings.
• The company remains 25%-30% behind its 2014 throughput high-water marks, suggesting that recent operational initiatives targeting transaction capacity could provide a multiyear lever for growth.

Chipotle Bears Say

• Consumer spending may shift toward grocery and convenience store channels if the macroenvironment continues to deteriorate.
• Input availability for key inputs like avocado, cilantro, and poblano peppers could complicate international expansion, with the company forced to rely on imports rather than farm-to-table suppliers in certain markets.
• Competition for real estate with drive-thru capacity has increased, potentially forcing the chain to pay a premium for those pads and posing a risk to restaurant margin expansion.

This article was compiled by Susan Dziubinski and Sylvia Hauser. Data as of Nov. 6, 2024.