With comparable store sales growth slowing, Chipotle Mexican Grill, Inc. (NYSE:CMG) most rely on new-restaurant expansion to drive revenue growth. Luckily, increasing the store count hasn’t been an issue thus far, and the firm remains on track to open 160-180 new restaurants this year alone. Still, total revenue increased just 13.4% year-over-year during the first quarter, and it appears as though the company’s revenue growth rate will fall to the mid-teens during 2013.
Other cracks are beginning to form in the Chipotle Mexican Grill, Inc. (NYSE:CMG) story. Fierce competition from Yum’s Taco Bell appears to be slowing Chipotle’s pace of market-share expansion. With lower-priced substitutes available, Chipotle doesn’t have much room to raise prices—which should further stall same-store sales growth and limit margin expansion. Additionally, Valuentum believes the incremental sales growth from new store openings will begin to cannibalize existing locations (decreasing the marginal benefits of new stores to the firm’s top and bottom lines).
ShopHouse begins to expand…
Enter ShopHouse, Chipotle Mexican Grill, Inc. (NYSE:CMG)’s take on Southeastern Asian cuisine. The company’s current location in Washington, D.C. will be joined by two new stores in California over the summer, as well as a location in D.C.’s Georgetown neighborhood. The concept receives mostly positive reviews thus far (according to Yelp), and as we can tell from the image below, it is Chipotle-inspired.
Not surprisingly, the concept has started out slow, as it should: we’d be disappointed in a large nationwide roll-out of a concept that consumers aren’t crazy about. If Ron Johnson tested his J.C. Penney Company, Inc. (NYSE:JCP) changes, he might still have a job. From what we’ve gathered, we think the concept could be a hit. At the moment, there isn’t much healthy Asian-inspired fast-food available in the United States, so ShopHouse fills a void in the marketplace.
The expansion isn’t a slam-dunk…
Even though we like the idea, we do not believe the concept justifies Chipotle Mexican Grill, Inc. (NYSE:CMG)’s premium valuation. For one, the restaurant is still in its very early stages. The potential for blockbuster success is there, but fast-food is a crowded, uber-competitive space. And it’s certainly feasible that ShopHouse’s market potential could be significantly smaller than Chipotle’s market potential.
Additionally, we think Chipotle Mexican Grill, Inc. (NYSE:CMG) is fostering a competitor with its ShopHouse concept. Both restaurants will be fighting for middle-class lunch and dinner dollars in the same price-range, with a similar experience. We doubt it will be a zero-sum game, but we think ShopHouse could eat into the core Chipotle business, to a certain degree.
Finally, the logistics of running two separate fast-food restaurants is difficult. Just a few years ago, Chipotle was owned by McDonald’s Corporation (NYSE:MCD), which has also owned Boston Market, Aroma Café, Donatos Pizza, and a stake in Pret-A-Manger. McDonald’s Corporation (NYSE:MCD) divested all of these properties over the years, and it seems that focusing on different concepts can distract from the core business. Of course, Yum! has largely been able to avoid this issue, but it has rid itself of non-core assets in the past few years as well. Further, McDonald’s Corporation (NYSE:MCD) same-store sales growth has been largely disappointing over the past year. Still, the very last thing Chipotle Mexican Grill, Inc. (NYSE:CMG)’s management team should do is divert too much attention from its cash cow.
Valuentum’s Take
Although Valuentum likes the ShopHouse concept, it carries several operational risks without the necessary benefit to justify Chipotle’s current valuation. In Valuentum’s view, Chipotle makes a wonderful product, and we assume ShopHouse’s take on Asian is comparably good.
Nevertheless, Valuentum can’t help but think the firm’s current valuation looks out-of-whack with fundamentals. Growth is clearly slowing, and the days of 20%+ revenue expansion appear to be over. We are exploring opening a bearish position on Chipotle Mexican Grill, Inc. (NYSE:CMG) in the portfolio of our Best Ideas Newsletter. For Motley Fool’s take on Chipotle, take our Special Report below.
RJ Towner has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill (NYSE:CMG) and McDonald’s Corporation (NYSE:MCD). The Motley Fool owns shares of Chipotle Mexican Grill and McDonald’s.
The article Does ShopHouse Justify Chipotle’s Valuation? originally appeared on Fool.com.
RJ is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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