Chipotle Mexican Grill, (NYSE:CMG) has had a fantastic 2011 which saw the stock rising more than 60%. It was a stellar year for the restaurant industry in general, as McDonald’s (NYSE:MCD), Yum! Brands (NYSE:YUM) and Starbucks (NASDAQ:SBUX) all outperformed the broader indices significantly. However, we feel Chipotle’s past record of delivering better-than-expected results has led the stock to be overvalued before the Q4 earnings, which is scheduled to be announced on February 1. Moreover, we are skeptical about the rising food and labor costs that might eat into its profitability.
Food and Labor Costs May Spoil the Party
Food costs, as a percentage of revenues, rose 2.5% last quarter and now constitute 33% of total revenues. The years 2008 and 2009 saw commodity prices plummet and as a result restaurants were able to maintain healthy profits. Chipotle benefited by locking in prices when they were relatively low in 2009. Now that the commodity costs have firmed up, the company will have to raise the prices or take a hit on its profit margins.
Chipotle also opened its first Asian-cuisine restaurant named ShopHouse Kitchen in Washington D.C last year and is looking to open more such restaurants.  Often, restaurants in the initial stages survive on thin margins due to increased marketing and promotions.
If the company decides to increase menu prices to restore profit margins, then we might see slower growth in the average number of visits per restaurant per year. This will in turn put downward pressure on the stock price.
Comp Sales Figures Exaggerated By Price Rise
Chipotle witnessed more than 11% increase in the comparable restaurant sales last quarter (inclusive of a one-time price increase of 4.5% across 80% of its restaurants). For Q4, the comp sales will likely be impressive as well since the prices were increased in July 2011. For the year 2012, we forecast lower comparable restaurant sales growth since the company doesn’t plan any menu price increase this year. We feel the stock has drifted away from fundamentals and are cautious for the time being.
We have a $321 price estimate for Chipotle, which is about 10% below the current market price.Notes: