Opportunity in Chipotle?

chipotle

Chipotle (NYSE:CMG) has recently found itself to be the punchline of many late night television jokes after its E. Coli incident. The stock is down over 45% from all time highs in October. This E. Coli outbreak has come after the stock has posted impressive comps for a long period of time. Yesterday the company filed an 8-K indicating Q4 comps were -14.6%. I am expecting Q1 to be horrible too considering they had a 10.4% comp in Q1 2015. The big question is if they can get their customers to come back. By understanding other food borne outbreaks in the past, one might be have an idea about what is ahead for Chipotle. Food borne outbreaks worth looking at include Blue Bell (2015), Taco Bell (2006), Jack in the Box (1993).

These three outbreaks were all handled differently. Jack in the Box was the worst because they initially blamed others which became a PR nightmare. Chipotle has done a pretty good job handling the incident. In all three outbreaks listed above there is one commonality. Customers forgot about the outbreak and resumed consuming the food they like. Eventually this could be the case with Chipotle. However, it’s probable that the company could post a -10% to -20% Q1 2016 comp when looking at their Q1 2015 comp and the -30% comp they had in December.

Despite all of the recent negative headlines, Chipotle is a great company. They use 68 quality ingredients across the entire menu compared to typical fast food where a single item have can as many as 100 ingredients, many of which are chemicals. This high quality food will help customers come back faster than if it was a traditional fast food restaurant. Chipotle is making investments in mobile technology and the company is adding a second order line just for its online and mobile orders. It’s like having a store within a store. In addition, the company has partnered with tremendous delivery services like Postmates and Tapingo. Both are producing 30% quarterly growth.

Chipotle will soon launch its new mobile technology which will include a mobile payment method. The company has discussed using Apple Pay or something similar. This is a big opportunity because it will collect data about their customers in order to better meet their needs. Chipotle hired Curt Garner away from Starbucks in Q3 2015 to be the CIO. Curt Garner helped Starbucks go from 2,000 stores to a global powerhouse. He is an exciting addition to the company and could make a big difference in the roll out of the new technology.

Historically Chipotle’s valuation has been rich. An intrinsic valuation is tricky considering they retain all profits to reinvest in opening new stores or buying back stock. Not to mention, projecting future growth based on historical growth rates is usually not accurate. Valuing the stock on a relative basis makes more sense in my opinion. I like to compare Chipotle to Starbucks (NASDAQ:SBUX) because they are similar in terms of risk, growth, and cash flows. Relatively Chipotle is cheap on nearly every metric against Starbucks.

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This hiccup for Chipotle has reset expectations. Prior to it, the company was wildly expensive. Expectations have been reset and as the company distances itself the gap between Starbucks 31 P/E and Chipotle’s 26 P/E may be closed. If they can close the P/E gap in 2017 and earn just $15.20 per share which assumes no earnings growth for the next two years, shares could be worth around $470. This represents 13% upside assuming no growth. This would be huge shock considering they have nearly doubled their earnings in the last three years.

Chipotle will open an estimated 190 new stores in 2016 which equates to a 10% increase in store base. The company is also buying their stock back hand over fist. In Q4 the company bought about $340 million worth of stock and the board approved an additional $300 million buyback.

Chipotle has tons of growth ahead with only about 1,850 stores open including the stores in Canada and the UK. The new ShopHouse and Pizzeria Locale restaurants only account for 13 stores and these two ideas could together have more stores than Chipotle stores down the road.

 

 

 

Wal-Mart’s Investing In Growth

Wal-Mart

Wal-Mart has been categorized as a struggling company over the last few months. Investors were disappointed in October to hear that EPS growth would be negative in fiscal year 2017 due to the investments in Wal-Mart’s associates and its e-commerce technology. Many analysts are also concerned with the decline in operating margins. However, Wal-Mart has an excellent track record of making investments that produce growth. In addition, there are many bright spots in the business.

One of Wal-Mart’s strongest points of growth in FY 2016 has been food. In Q3, food was the fastest growing category despite minimal inflation. The growth in food can be attributed to the success of Neighborhood Markets which delivered an 8% comp in Q3; their 19 consecutive quarter with positive comps. This year the company has began a grocery pickup service where customers can order from Sam’s Club’s or Neighborhood Markets and pickup their items without getting out of the car. Customers that use the online grocery pickup spend 50% more than similar customers that shop only in stores. I would anticipate this service to take some time to develop and become widely used but it is an exciting investment and an innovative idea that will generate future growth.

The company is looking to innovate and fight back against Amazon but it is also focused on customer experience in existing stores. Wages have been boosted and employees are receiving more training to enrich the customer experience. Research indicates that increasing wages actually increases sales while also cutting down on turnover which is costly to every company. Costco has historically had the lowest turnover in retail do to their favorable wages but expect Wal-Mart to close the gap.

As the company invests in growth and boosts its image by paying better wages it will begin to regain its competitive advantage. Wal-Mart announced last quarter that John Furner who did a spectacular job in China as the Chief Merchandising and Marketing Officer, will be returning to Sam’s Club as the Chief Merchandising Officer. This is a catalyst for the company going forward. Despite slow economic growth in China, Wal-Mart has done well and I think John Furner will make a difference in the Sam’s Club comps going forward.

The biggest investment for Wal-Mart over the next few years will be e-commerce. They will spend $1.1 billion in FY 2017 and $1.3 billion in FY 2018. It is expected that e-commerce will grow at 20%-30% a year which is in line with Amazons projected revenue growth over the same period. The company will upgrade its mobile app and invest in multiple online channels.

The stock was certainly punished in 2015 being down nearly 30%. The company has a trailing PE of 13.5 and a forward PE of 14.8 although I view the EPS guidance to be low considering the way it is investing along with the $20 billion worth of stock they will buy over the next two years. This buyback indicates that Wal-Mart will buyback about 10% of the company over the next two years.

In FY 2014, Wal-Mart earned over $5 per share. Current estimates expect Wal-Mart to earn just $5.30 in FY 2019 meaning expectations are set for the company to only see 6% growth over the five years while revenues are expected to grow 14% over the same period. With the $20 billion buyback, estimates could be closer to $5.50 for FY 2019 which I believe is conservative considering the company’s impressive historical ROI. With the buyback program, Wal-Mart could actually make less than it did in 2012, 2013, or 2014 and still make $5.50 in FY 2019. Over the last ten years the stock has traded with an average PE of 15. At $5.50 and an average PE, the stock could be near $83 representing about 24% upside. The stock also pays a nice 3.1% dividend. At $5.50 a share in FY 2019, investors could earn an annualized return of about 10% a year with lots of growth beyond FY 2019.