Last April, he told investors to short Apple Inc. (NASDAQ:AAPL), reasoning that shares of the tech giant were poised to drop to $425. That called proved stunningly accurate, as shares hit his price target earlier this year.
Now, he thinks investors should short Chipotle Mexican Grill, Inc. (NYSE:CMG). At last week’s Ira Sohn investment conference, Gundlach explained why he believes Chipotle is a good short.
Gundlach’s Chipotle argument
Gundlach’s argument against Chipotle Mexican Grill, Inc. (NYSE:CMG) is primarily based on three factors: its excessive valuation, competitive threats, and a poor chart pattern.
I’m a skeptic of technical analysis, so I’ll avoid his last argument. But to be completely fair, Gundlach’s Apple Inc. (NASDAQ:AAPL) call was based largely on its chart — he noted that Apple started to form a parabolic pattern near $425. Perhaps his technical analysis will again serve him well.
But rather, it’s his other two arguments I take issue with.
Chipotle’s excessive valuation
Shares of Chipotle Mexican Grill, Inc. (NYSE:CMG) are currently trading with a price-to-earnings ratio near 40. This more than double the broader S&P 500’s.
Does this alone make Chipotle Mexican Grill, Inc. (NYSE:CMG) a good short? Absolutely not. There are plenty of stocks that trade at (what might appear to be) excessive valuations.
Take Netflix, Inc. (NASDAQ:NFLX), for example. Shares currently trade with a PE ratio over 560 — that’s nearly 30 times more expensive than the S&P 500. Given that it’s so expensive, I’m not saying Netflix is a good investment here (though Whitney Tilson presented it a Value Investing Congress last week). Certainly, Netflix, Inc. (NASDAQ:NFLX)’s stock could crumble tomorrow.
But if a trader shorted Netflix based on valuation any time in the last few months, they’ve been run over. Back in December, Netflix had a PE ratio over 100. Not nearly as high as today, but several times greater than the broader market.
But Netflix, Inc. (NASDAQ:NFLX) is just one example; plenty of stocks have continued to reward investors despite being relatively expensive: Amazon.com, Inc. (NASDAQ:AMZN), salesforce.com, inc. (NYSE:CRM), Lululemon, and Under Armour, to name just a few examples.
In short, growth stocks can continue to deliver as long as they remain just that — growing. That brings us to Gundlach’s other argument: competition.
Can Chipotle survive the competition?
The last few slides of Gundlach’s presentation were filled with pictures of taco trucks. Gundlach noted that Chipotle Mexican Grill, Inc. (NYSE:CMG) was facing low barriers to entry — that anyone with a taco truck was a potential competitor.
This is where I find Gundlach’s argument to be at its weakest — he doesn’t seem to fully grasp Chipotle’s market.
Chipotle isn’t just a seller of “gourmet burritos” — it’s fast food reimagined. People going to Chipotle Mexican Grill, Inc. (NYSE:CMG) don’t go there because they want TexMex; rather, they go to Chipotle because it offers relatively cheap, relatively high quality food served promptly.
The restaurant business in general is immensely competitive — not only do restaurants have to compete with taco trucks, they must compete with the obvious alternative of customers cooking in their own homes. Yet, this hasn’t stopped fast food chains from thriving.
David Einhorn’s Chipotle bear case
Greenlight Capital’s David Einhorn made a similar case against Chipotle last October, with one exception. Einhorn didn’t cite taco trucks — he saw Chipotle facing pressure from Yum! Brands, Inc. (NYSE:YUM)’ Taco Bell.
Taco Bell has been a great part of Yum! Brands, Inc. (NYSE:YUM)’ business in recent months, particularly as its KFC brand continues to face headwinds in China. The Doritos Locos taco proved to be a smash hit, and might have lead to the creation of 15,000 jobs.
But therein lies Taco Bell’s problem when it comes to challenging Chipotle Mexican Grill, Inc. (NYSE:CMG). Although Taco Bell has pushed its Cantina Bell Menu (a collection of higher quality offerings marketed almost directly at Chipotle’s customers) its continued focus on the low end of the market ensures that it will never attain the same image as Chipotle.
In fact, earlier this month, Taco Bell said it would expand the $1 section of its menu. While that might help the fast food giant, it won’t win it any favors with the Chipotle crowd. A key part of Chipotle’s branding efforts has been the promise of “food with integrity” — locally sourced, organic whenever possible.
Like McDonald’s Corporation (NYSE:MCD) inability to challenge Starbucks Corporation (NASDAQ:SBUX) with its McCafe beverages, Taco Bell will never challenge Chipotle as long as it sticks to its classic, lowest-common-denominator image.
Investing in Chipotle?
So should investors put money to work in Chipotle Mexican Grill, Inc. (NYSE:CMG)? Maybe not. As Gundlach notes, the stock does seem to be a bit pricey, and its chart could be a bearish sign for those who subscribe to technical analysis.
However, shorting Chipotle based on Gundlach’s argument seems to be equally as dubious. Although expensive, stocks can always become more expensive. At the same time, competitive threats seem to be based more on theory than in reality.
The article Why Jeff Gundlach Is Wrong About Chipotle originally appeared on Fool.com and is written by Salvatore “Sam” Mattera.
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