Why Einhorn Should Be Shorting Whole Foods And Not Chipotle

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By Akram's Razor :

In April, I published a article titled, " The Birken Burrito ," in which I recommended shorting Chipotle Mexican Grill ( CMG ). For those that read the piece, the main focus of my short thesis was Chipotle's then seemingly unfathomable premium valuation to other popular food franchises and comparable premium brands.

To put things in perspective, I compared Chipotle's then 31x EV/EBITDA multiple to the 32x multiple of Hermes (HESAF.PK) because that's precisely where you needed to go to find a retailer trading on par with Chipotle's valuation. Well, a few months and 40% later, Chipotle has come back to earth and is now even an Einhorn short. Now, while I can see where Einhorn is going with this trade, I personally would not short Chipotle here. (I'd actually now rather be long it over almost any other name in the space)

Simply put, it is no longer a great company with a relatively unattractively priced stock. At its current share price, Chipotle trades at a forward eps multiple of 26x that is on par with Buffalo Wild Wings' ( BWLD ) 23x and Panera's ( PNRA ) 24x. It is also now trading at an EV/EBITDA multiple that is roughly equal to Starbucks ( SBUX ). So, why short Chipotle at a comparable earnings multiple to its peers when its operating margins are far superior? (17% versus 9% and 12.5% for BWLD and PNRA, respectively)

Taco Bell's Cantina Bell Menu launch was a nice added boost for my short thesis into Q2 earnings especially considering Chipotle's management had already been cautioning about H2 tougher comps on their Q1 call, but it is not a long-term or even intermediate term competitive concern. This is because Chipotle's brand identity is distinctively different, and they have invested so heavily in building that brand that I can't see Taco Bell taking any meaningful share. Thus, risk/reward here makes little sense if you view Chipotle within the context of its broader peer group. But the market being what it is there is always a stock that looks the way Chipotle did a few months ago, and in my humble opinion that stock is now Whole Foods ( WFM ).

Here is another great company that has been growing earnings at a very healthy clip and has a religiously loyal customer base. Simply put, Whole Foods is to groceries what Chipotle is to casual dining. It sells a premium product, and has an even more premium priced stock. At its current share price, Whole Foods trades at 42x trailing earnings, 34x forward earnings, and at about 18x EV/EBITDA. Comparing it to traditional grocers is an exercise in futility because those names trade at low single digit earnings and EV/EBITDA multiples [Safeway (SWY) for example trades at 4.5x trailing EV/EBITDA and 7.5x forward earnings]. Those looking for comparable names somewhere in Whole Foods' market cap league need to go outside of the traditional grocery space, and when you do that Chipotle and Starbucks make the most sense. Take a look ...

Operating Margins

EV/EBITDA

Forward P/E

Chipotle Mexican Grill

17%

16x

26x

Starbucks

13%

15x

22x

Whole Foods

6%

18x

34x

As you can see, Whole Foods is the most expensive name in this group despite its much weaker operating margins. This is interesting because when most people defend Whole Foods valuation, they always cite their impressive sales per square foot and freakish industry leading profit margins as reasons the stock can't be compared to other grocers. But if you stick Whole Foods in with the industry benchmarks in 'branded' food retail, the stock still looks expensive because at the end of the day it is still a grocer. Now you can criticize this exercise and say there is no way Whole Foods can be able to stack up on an operating margin basis with the likes of Chipotle and Starbucks, and I won't disagree with you. But if you are going to go that route, don't defend Whole Foods valuation by saying it is not a 'traditional' grocer as the brand has evolved into something more like a restaurant experience, and thus deserves a multiple that reflects that.

So, instead of shorting Chipotle, I think Mr. Einhorn should take a closer look at Whole Foods here. Yes, Supervalu (SVU) and Safeway are not going to come up with a new Cantina Bell like menu reason to short their competitor, but at these valuations, you don't need that. Whole Foods - the stock's worst enemy going forward is itself, much like Apple (AAPL) over the past few weeks; it is highly susceptible to running into the ever increasing expectations wall. However, unlike Apple shares, Whole Foods investors don't have the luxury of a "the stock is cheap" argument. Short or buy some out of the money puts until the name corrects 20-25% or go buy some Starbucks or Chipotle shares as they are a lot cheaper and still sporting robust business models.

Disclosure: I am short [[WFM]]. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

See also Mortgage-Backed Securities Offer A Raw Deal on seekingalpha.com



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: BWLD , CMG , PNRA , SBUX , WFM

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