Shares of casual dining chain Chipotle Mexican Grill (CMG) have been hammered since reports of E. coli outbreaks across the country have caused a material decrease in customer traffic during the fourth quarter (double-digit same store sales declines have been confirmed by the company). After peaking at more than $750 in August, the stock now fetches a little more than $500 per share.
This is definitely the kind of short-term sell-off I pay close attention to as a long-term, contrarian investor. History tells us that restaurants dealing with outbreaks like this see a drop in customer visits but eventually recover. Within a year or two, after the headline news has abated and the health issues rectified, people revert to their previous dining habits. With a perennially high valuation stock like Chipotle, a negative event like this can often be one of the only ways investors can get a bargain for their portfolio. So am I loading up on the shares at the current ~$520 price?
Not yet. Simply put, I don’t find the price extremely compelling, even after a 30% decline. Before the E. coli cases came about, Chipotle was having quite the year from a financial standpoint. Revenue was tracking at about $4.7 billion for 2015 (+15%) with operating cash flow approaching $800 million (about as high a profit margin as you will find in the industry). I estimate maintenance capital expenses for the company’s existing restaurants to be quite low (less than $100 million annually), so CMG’s existing units were on pace to produce free cash flow of $700 million per year before the outbreaks.
The problem for value investors like myself is that the stock’s valuation has gone from insanely high ($24 billion at the peak, or about 34 times free cash flow) to a lower level today (23.5 times free cash flow) which is still fairly high. Despite CMG’s growth outlook, I would have valued CMG at 20 times free cash flow before the recent drop (~$450 per share). Now that customer traffic has dropped more than 10% and will likely take at least a year to recover, I would want a discounted price to reflect the time it will take for the company to fix the problem once and for all and see visitors return to their normal habits. A 25% discount would mean a stock price in the 330’s. Accordingly, I do not think I will be bottom-fishing in CMG shares anytime soon. There are just too many other restaurant chains that I think are meaningfully more attractive from a valuation perspective.
Full Disclosure: No position at the time of writing, but positions may change at any time