Bulls Haven't Had Their Fill of Chipotle

Even after an 88 percent rise for shares of Chipotle Mexican Grill (CMG) thus far in 2010, analysts and investors continue to find them appetizing.

A chain of so-called fast casual restaurants specializing in a limited menu of burritos, tacos, and other Mexican dishes, Chipotle wins "buy" ratings from 12 of 21 sell-side analysts surveyed by Bloomberg—with no "sell" ratings on the stock. Their enthusiasm is reflected in the fact that Chipotle is the best-performing restaurant stock in the broad Russell 3000 index. Shares hit an all-time high on Sept. 10.

What appeals to investors? "There is an appetite on [Wall] Street for growth stocks" in the restaurant industry, says Stifel Nicolaus (SF) analyst Steve West. "There really aren't many." Other restaurants have felt the effects on consumers of the recession and an unemployment rate still at 9.6 percent. Among 37 restaurant stocks in the Russell 3000, 15 saw sales drop last quarter from a year ago, and only six experienced double-digit growth.

Despite the economic downturn, Chipotle's total revenue jumped 20 percent last quarter, second-best in the restaurant group, after 21 percent growth at BJ's Restaurants (BJRI). Same-store sales rose 8.7 percent last quarter—the third-highest among restaurant stocks, after Panera Bread (PNRA) and Starbucks (SBUX). "One of the most impressive things about this company is [its] ability to drive more customers in the door each year," says Robert Derrington, an analyst at Morgan Keegan.

Investors impressed by Chipotle's results include CNBC's Jim Cramer, who, according to Bloomberg News, touted the stock on the July 26 episode of his show Mad Money.

Heading for a Fall?

After Chipotle's rapid rise this year, there is increased concern that shares are getting too expensive. Investor hopes are high, West says. If, in the future, Chipotle "shows the slightest sign of weakness in fundamentals," he says, "the stock will get hit pretty hard."

Chipotle's price-to-earnings ratio, a common measure of a stock's valuation, is 34, compared to a p-e for the entire Russell 3000 of 16. "We think that's too expensive a premium to pay," says Derrington, who has a neutral "market perform" rating on the stock. He would advise investors to buy again if the p-e fell closer to 20.

Stifel's West still has a "buy" rating on the stock. He says Chipotle will be a long-term success story. The chain has about 1,000 outlets in the U.S. now, and he estimates the number eventually could grow to 4,000 to 5,000. The chain expects to add 120 to 130 new restaurants this year, says Chipotle spokesman Chris Arnold.

In a Sept. 1 research note, William Blair analyst Sharon Zackfia called Chipotle "one of only a handful of publicly traded restaurant companies capable of maintaining a double-digit pace of expansion over the next five years."

Despite an emphasis on quality ingredients, profit margins at Chipotle outlets are wide, West says, and the restaurant's simple menu is a great advantage. "They keep everything very, very simple," he says. "It's a big part of their success."

Rising Cost of Ingredients

To drive growth and differentiate its brand from those of other chains, Chipotle this year created an advertising campaign—with the slogan "food with integrity"—that extols the higher quality of its ingredients.

Nonetheless, Arnold, the Chipotle spokesman, says the company is not investing a lot of new money in marketing. "We would rather spend money investing in food and better ingredients," he says. "[We] really believe it's that good food we serve that keeps people coming back."

Asked what could taint the recent improvements in Chipotle's results, analysts cite the possibility of higher labor costs or the effects of an unpredictable economy. The most common worry, however, is the possibility that the chain could end up spending much more on those quality ingredients.

On Sept. 10, corn futures hit a 23-month high on speculation the U.S. crop will be smaller than forecast. Food commodity prices, as reflected in the Dow Jones-UBS Agriculture Total Return index, are up 23 percent from 12 months ago.

Wells Fargo estimates food costs for restaurants will rise 13 percent this year and another 3 percent in 2011, with beef, chicken, cheese, corn, and wheat all above 2009 levels.

For now, like customers willing to plunk down $6 for a chicken burrito, investors are willing to pay a premium for Chipotle's future growth.

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