Chipotle Stock: We support Bill Ackman’s position (NYSE:CMG)

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Bill Ackman’s Pershing Square recently published a bullish thesis on Chipotle (NYSE:GCM) stocks, citing “creating shareholder value” as the catalyst. After reviewing the stock broadly, we also believe Chipotle offers decent value for money as its fundamental growth metrics are aligned due to to its impressive operating leverage.

Additionally, we believe Chipotle is a “best-in-class” consumer staple stock to buy in the current environment and therefore give the stock a strong Buy rating.

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Data by YCharts

Synchronization of operational growth

The big talking point surrounding Chipotle’s current financial performance is its impressive same-store sales. The company’s second-quarter results indicate that its comparable sales rose again, up 10.1% year-over-year.

Comp.  Sales

Commercial quantification

Chipotle’s same-store sales growth comes with a 2.3% year-over-year increase in operating income, a 3-year sales CAGR (compound annual growth rate) of 16.20% and a gross profit margin of 38%. Cumulatively, these metrics suggest the company is formulating a secular growth model, giving investors plenty of reason to keep an eye on Chipotle’s stock.

financial state

Chipotle

We believe Chipotle’s competitive advantage stems from its ability to deliver high quality food at affordable prices. In addition, the company’s menu is suitable for dine-in and take-out. As such, Chipotle is able to leverage its in-store presence and food delivery space (which is growing at a CAGR of 12%).

financial state

Chipotle

I built a spreadsheet containing Chipotle’s operating and total leverage ratios to analyze the company’s operational efficiency. The degree of operating leverage ratio paints a picture of a company’s sensitivity to changes in revenue, while the degree of total leverage measures the sensitivity of the company’s net income to sales.

Essentially, we examine 1) what effect a potential convergence of sales and input costs will have on the firm’s income statement and 2) how well the firm’s capital structure adapts to changes in sales.

Based on my model, Chipotle’s bottom line is not extremely sensitive to changes in its sales. Typically, this provides a safety net against any macroeconomic headwinds. Moreover, the company’s capital structure shows that it is more than capable of handling a systemic shock.

Levels of leverage ratios

Pearl Gray Equity and Research; Looking for Alpha

Just a few remarks on my calculation.

I wrote off depreciation and amortization as well as write-downs, closures and disposals of assets. Additionally, I split the pre-opening costs equally between fixed and variable.

If you want to corroborate or do your own math, check out the financial statements here (link).

Evaluation

It would be easy to look at a bunch of stationary price multiples and conclude that Chipotle is overvalued at a GAAP price/earnings ratio of 57.43. However, the fact is that the performance of Chipotle stock is not well described by its price multiples (see chart below).

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Data by YCharts

Based on our observations, the success of Chipotle stock is driven by two main factors, 1) profitability and 2) growth. The company’s main profitability indicators suggest that it is in sublime shape.

The company’s rate of return on invested capital of 17.64% indicates that it monetizes its working capital advantageously. Additionally, Chipotle’s common stock yield of 34.94% speaks to the company’s knack for delivering extraordinary residual returns to its common investors. Finally, a 3-year EBITDA CAGR of 25.45% tells us that Chipotle is adding to its underlying fundamental value at an exponential rate.

Return on invested capital 17.64%
Return on common equity 34.94%
3-year EBITDA CAGR 25.45%

Source: Search Alpha; GuruFocus

I chose to use a profit-based price target as a means of valuation. The formula may seem oversimplified, but it’s a handy tip. By multiplying the final P/E with the earnings per share expected by analysts, we are able to obtain an implied price target.

Based on my parsimonious calculation, Chipotle stock could reach a price target of $2461 by December of next year. Ideally, you should take this price target with a grain of salt as there are many other variables to consider; however, it is a valuable indicator.

Price target

Pearl Gray Equity and Research; Looking for Alpha

Risks to consider

The biggest risk to Chipotle is the volatility in the global economy it faces. All companies and stocks will inevitably be susceptible to a deep recession and a bear market. Based on key economic variables and stock market risk premia, all equity securities are at risk at this time.

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Data by YCharts
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Data by YCharts

In addition, Chipotle has statistical problems. The stock’s Sharpe ratio falls below 1, meaning its historical risk/reward profile is questionable. Therefore, the stock presents a high risk of underperformance in a risky market.

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Data by YCharts

Last word

Chipotle seems to be an outlier in today’s market. The stock is trading at a significant discount due to the company’s excellent operating leverage, comparable store sales growth and continued profitability.

After evaluating the stock’s risk versus return variables, we assign a high buy rating to Chipotle.

If you’re interested in more advanced analysis, be sure to keep an eye out for our soon-to-be-launched marketplace program, “The Factor Investing Hub”. FIH is an AI-driven “smart beta/factor investing” portfolio management concept with the goal of balancing long-term portfolios against “factors”.

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