A Burrito Bubble? 5 Things to Consider Before Investing in Chipotle

The Numbers Guys submits:

Chipotle Mexican Grill ( CMG ), a market darling touted by Jim Cramer as one of his C.A.N.D.I.E.S. stocks (Chipotle, Apple, Netflix, Deckers Outdoors, Intuitive Surgical, Express Scripts and for which he screams "buy, buy, buy," has been a phenomenal growth story over the last few years in a time when many companies have been fighting for survival. With the stock price recently trading at an all-time high above $180 and a P/E ratio over 35, double that of most other notable restaurant chain stocks, one has to wonder if there is a giant "burrito bubble" getting ready to pop!

With Chipotle's earnings due out this afternoon with an average analyst estimate of $1.30 per share, there is no reason to expect Chipotle won't easily surpass this projection, given its recent history of eclipsing quarterly expectations. Everybody loves a growth story, especially for a company that is building some really good brand recognition and provides great tasting food. But how long can Chipotle reasonably sustain this kind of growth and earnings? With a stock price that has increased over 100% in 2010, has Chipotle's valuation gotten way ahead of itself?

Before buying into the whole enchilada at a burrito busting price of $180+ per share, here are five things to consider:

  1. Boston Market

Once a market darling in its own right in the early to mid '90s, this high growth fast food chain with a great new concept was opening one store per day at its peak. What seemed like a recession-proof business, flourishing in some hard economic times, with projections of radical growth along the lines of Chipotle, it began to fail just as the tech boom was building. One would have thought with a recovering economy that Boston Market would have done that much better. But alas, the wild growth, changing menu and loss of hype akin to TCBY (The Country's Best Yogurt), Boston Market ultimately filed for bankruptcy and was bought for less than $200M by McDonald's which has since retooled the operation. The lesson to be learned, borrowing a quote from Public Enemy's Flavor Flav, "Don't Believe the Hype," or at least be very wary.

  1. McDonald's Cashed in their Chips (and Salsa)

Odds are that when the perennial powerhouse of an industry invests in something, there is a better than average shot at success. But what happens when that same powerhouse jumps ship? It could be that the ship might have run its course.

McDonald's ( MCD ), after gaining controlling interest of Chipotle in 1999 and helping drive significant growth and an IPO in January of 2006 decided that 10 months after Chipotle went public it was time to cash in, divesting of their entire interest. Of course McDonald's said at the time it was so they could focus on their core business and generate cash to buy back some of its own shares, but why would they completely jump ship if they believed Chipotle had so much upside? Of course even the seemingly smartest guys in the room could be wrong once in a while, and they obviously didn't time the market correctly as the stock price has tripled since they sold out, but when it comes to knowing the fast food business, I have to believe the smart money is going to follow McDonald's lead.

  1. It's Only Burritos not iPads

There are some people that can point the origins of the burrito back to the 16 th century Aztec peoples of Mexico. The point here is that burritos aren't new. It isn't like Chipotle figured out how to put a man on the moon or build a better iPad! They are competing in a "me too" business with competitors like Taco Bell, Moe's Southwest Grill, and many other fast food chains as well as local and regional Mexican restaurants. They do not have a patent on the burrito. The barriers to entering this business are low. It is difficult to sustain the kind of 20% plus EPS growth that Chipotle analysts are figuring in to their price targets when your next door neighbor can open up a taco stand tomorrow and start stealing market share.

  1. Primed for a Pullback (Technically Speaking)

In the short term, Chipotle is showing several overbought signals from a technical standpoint. On the daily chart, there is strong bearish divergence on the MACD Histogram and Force Index (i.e. histogram and force index are trending down while recent price is trending up) signaling a weakness in the recent run up in price (see chart below). The stock price has also jumped about 20% from its recent consolidation around $150 per share without much of a breather. The Money Flow Index, which combines volume and price to gauge how much money is flowing into the price trends, hasbeen hovering near overbought levels as well.

  1. Short Interest is Up

Short interest in Chipotle stock is up almost 45% from July through September and currently represents approximately 13% of the shares outstanding. This could be a signal that many investors believe the stock is due for a pullback and is overvalued. Contrarians may disagree with the crowd and believe a short squeeze is coming that will eventually drive the stock price higher, but given the other factors mentioned above, the former seems like a more likely outcome.

Author's Disclosure: No positions

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

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

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