• CMG isn’t low-cost, however given spectacular progress it shouldn’t be.
• A protracted historical past of outperformance suggests the current dip might be purchased.
• However one key danger looms on the margin entrance.

Even with a 15% decline over the previous 4 weeks, Chipotle Mexican Grill Inc (NYSE:) inventory seems to be like a dicey decide right here. In a nervous market, shares commerce at 41x this yr’s consensus earnings per share estimate. Inflation and, probably, recession are each apparent dangers.

However basically, CMG does in actual fact look enticing on the dip. With out exaggeration, this could be the perfect restaurant enterprise of the century. Barring an excellent motive — and Chipotle did take an enormous hit from the e.coli outbreak of 2015 — CMG will not be going to be low-cost. And within the context of present progress, the valuation right here seems to be affordable at worst.

In fact, that in flip requires that present progress continues. On that entrance, there’s one key danger buyers can’t ignore.

Why Chipotle’s Valuation Is Higher Than It Appears

41x earnings is a steep value to pay on this market, however on the fee Chipotle goes, its earnings a number of goes to compress in a rush.

Earnings per share ought to develop about 31% this yr. For the time being, Wall Road consensus sees one other 29% enhance in 2023; even the low estimate implies 23% progress.

At 32x ahead earnings, and with 20%-plus progress going ahead, the basics right here can work. That’s notably true provided that progress doesn’t essentially have to finish.

Chipotle nonetheless sees a path to 7,000 places over time, up from a present 3,000. That retailer depend progress requires entry into small-town markets — and early returns from that technique are sturdy.

So long as same-store gross sales continue to grow, the regular increase from new eating places ought to drive earrings increased — and CMG inventory with it.

Inflation and Recession

One apparent concern is that the exterior surroundings will throw a monkey wrench in that technique. Inflation is a danger to any restaurant chain, even one like Chipotle that, relative to the {industry} as a complete, operates at a cheaper price level. Ought to inflation be mixed with a recession in 2023, Chipotle visitors probably slows, and so does progress.

This danger can’t be utterly ignored — nevertheless it’s price noting that Chipotle has managed by means of the present surroundings simply effective. On the restaurant stage, working margins year-to-date are optimistic, together with a 180 foundation level enlargement within the third quarter. And administration stated on the third quarter convention name that whereas the chain is dropping visits from lower-income clients, more comfortable patrons are buying with growing frequency.

Chipotle has to maintain executing, after all. But when 2023 seems to be like 2022, buyers ought to have some confidence that the chain will be capable of handle by means of.

Labor considerations the larger risk

That’s, assuming the corporate can maintain labor expense in test, and maintain its eating places staffed.

Right here too it’s been thus far, so good. Labor prices rose about 11% year-over-year within the third quarter, whereas income elevated 14%. 12 months-to-date, the 2 metrics have risen roughly in line.

However Chipotle is ramping up its retailer depend, and including drive-through lanes as nicely. Steering for 2023 suggests the full variety of eating places will enhance about 9%. As famous, a few of these new places will likely be situated in smaller markets which already could also be going through a stretched labor market.

Chipotle’s dimension and model probably give it an edge in opposition to different employers, however managing labor could be the most important problem the corporate faces in 2023. Wages that outpace income would strain the corporate’s industry-leading margins, and dim the bottom-line progress being created by same-store gross sales progress and new restaurant growth. However understaffed eating places might flip away clients, chipping away on the multi-year turnaround Chipotle has executed.

In consequence, buyers must belief administration, and the model. But when they do, this dip in Chipotle inventory is a chance.

Disclosure: As of this writing, Vince Martin has no positions in any securities talked about.