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Chipotle Mexican Grill, Inc. (CMG): Is David Einhorn’s Short Thesis About to Be Vindicated?

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David Einhorn’s short thesis on Chipotle Mexican Grill, Inc. (NYSE:CMG), delivered at last October’s Value Investing Congress, sent the stock diving once word spread that the famous short-seller thought the stock was too expensive. The stock has since climbed 25%, presumably making it a more attractive short.

However, even at 44 times earnings, the decision to go long or short Chipotle Mexican Grill, Inc. (NYSE:CMG) is not an easy one. Several factors will play a key roll in determining whether investors will make more money betting with the company or against the company.

Why it could be a buy

To many investors, Chipotle Mexican Grill, Inc. (NYSE:CMG) is just another restaurant in the fast-casual space that will grow at a moderately quick pace over the next decade. However, to consumers, Chipotle is an entirely different restaurant than, say Panera Bread Co (NASDAQ:PNRA).

GREENLIGHT CAPITAL David EinhornPanera also operates in the fast-casual space. It has slightly more locations than Chipotle Mexican Grill, Inc. (NYSE:CMG), and its long-term franchise agreements secure for it a predictable stream of cash flows. Moreover, Panera Bread Co (NASDAQ:PNRA) has an extensive supply chain and delivery network, which enables its restaurants to carry less inventory.

However, Panera Bread Co (NASDAQ:PNRA)’s restaurants do not generate nearly as much revenue as Chiptole locations, and its growth prospects are not quite as good. On the surface, this can be explained by brand equity; Chipotle Mexican Grill, Inc. (NYSE:CMG) is known for sourcing natural-raised food, whereas Panera is not known for anything in particular.

This enables Chipotle Mexican Grill, Inc. (NYSE:CMG) to ride the organic food trend currently overtaking the country. In addition to building streamlined stores that require relatively little capital, the health food trend will give a significant boost to Chipotle over the coming decade. As a result, the company’s profits will inevitably rise at a faster pace than the rest of the fast-casual space.

Why Einhorn is short

But David Einhorn is skeptical that Chipotle Mexican Grill, Inc. (NYSE:CMG)’s expected profit growth will materialize. The short-seller’s main argument is that, at such a high multiple of earnings, expectations are too high for a company that has low barriers to entry and an enormous liability in the form of Obamacare (Chipotle does not currently provide health care for its employees).

Moreover, Einhorn argues that Yum! Brands, Inc. (NYSE:YUM) Taco Bell poses a significant threat to Chipotle Mexican Grill, Inc. (NYSE:CMG) in the near-term. Taco Bell’s Cantina Bell menu is similar to that of Chipotle, except it is cheaper.

Einhorn conducted a survey of Chipotle Mexican Grill, Inc. (NYSE:CMG) customers and found that they visit Taco Bell at least as much as they visit Chipotle. Two-thirds of those customers said that Taco Bell’s Cantina Bell menu was “good,” while half thought it was better than Chipotle’s menu. As a result, Einhorn concludes, Chipotle is unlikely to stave off competition for much longer.

Is Taco Bell really a substitute for Chipotle?

Although Einhorn conducted a survey of actual customers, common sense suggests their responses are not representative of Chipotle Mexican Grill, Inc. (NYSE:CMG)’s broader customer base. Cantina Bell burritos range from $4.79 to $6.99, while Chipotle burritos normally go for $6 to $9. Logic would say that people who think Taco Bell is at least as good as Chipotle would opt for the lower price, but that does not seem to be happening.

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