Chipotle currently trades at a forward PE of 43—much higher than companies such as Panera Bread Co. (PNRA), Starbucks Corp. (SBUX), McDonald’s (MCD), and Yum Brands Inc. (YUM). The high PE reflects the market’s great expectations of Chipotle’s long-term growth as more people eat at Chipotle (higher same-store-sales) and Chipotle continues to expand nationally.
Premium to valuation
Indeed, Chipotle’s comparable restaurant sales and store counts growths have surpassed its peers and competitors over the past few years. And with comparable restaurant sales and store count growth moving back to the levels they were at in 2011 (see the previous part in this series), Chipotle’s forward PE doesn’t look that expensive. As long as Chipotle can maintain the growth rate we saw recently, investors will be rewarded. If earnings grow by ~29% in fiscal year 2014, and the market is willing to pay for Chipotle at 43 times 2015’s estimated earnings in a year, Chipotle’s share price would rise ~29%.
Earnings growth expectation
Analysts currently expect Chipotle’s earnings to grow ~24%—close to how fast the company’s earnings have grown over the past two years. But a forward PE of ~43x, based on comparisons against the company’s peers, suggests Chipotle’s growth is expected to increase roughly 30% annually over the next two years—which is what we saw for the latest quarter, 4Q13.
Should Chipotle’s performance deteriorate, the fast-casual restaurant could see a selloff—similar to what we saw with Twitter recently. When the market feels such high confidence about a company’s further prospects, even news that’s slightly less positive can send the stock tumbling hard.
Risk to rising forward PE
Rising-forward PE reflects market confidence in the firm for attractive growth, but the multiple is only attractive when such high earnings growth (or in this case, same-store sales growth) is sustainable. Companies trading at high forward PE multiples face the risk of tumbling in a downward spiral when earnings fail to meet guidance and the market’s expectations.
While management increased comparable sales guidance for the coming year from the low single digits to mid single digits, the guidance is below what the company experienced in the past—11.20% for 2011 and 7.10% for 2012. Management cautioned that comparable store growth will become increasingly difficult as the restaurant chain goes against the strong comparable store growth that emerged in the last two quarters of 2013.