Friday, January 08, 2010

Chipotle Mexican Grill (NYSE:CMG): Upgraded to Overweight from Underweight at Morgan Stanley

Morgan Stanley is making an interesting call on Chipotle Mexican Grill (NYSE:CMG) double upgrading the stock to Overweight from Underweight while raising their target to $111 (prev. $76).

Specific reasons they would own this stock in 2010:

- CMG will be the leading restaurant growth stock of any meaningful market cap, based on firm's work only 40% saturated in the US, with the ability to at least double and perhaps triple its current store base. That growth potential, combined its current rate of growth should command a valuation commensurate with that superior growth; today it does not

- 2010 EPS consensus is too low by ~10% just holding current margins flat

- CMG has more pricing power than investors believe and will use that to defend margins in 2010;

- SSS, specifically traffic, are poised to rebound with the economy, easier comparisons and company-specific drivers such as the introduction of kids meals and easier to navigate menu boards.

Pricing survey and store saturation analysis highlight opportunities. Morgan Stanley's proprietary pricing work suggests CMG’s prices are ~5–10% lower than peers on most items, providing pricing opportunities the market does not see and allowing CMG to hold best-in-class operating margins. Working with Morgan Stanley AlphaWise, their updated store saturation analysis suggests that CMG is only 40% saturated in the US.

There’s also a broader reason: With tighter budgets and less time, consumers are seeking out dining options that save time and money, especially relative to the casual dining alternative. CMG is one of two clear leaders in this “quick-casual” category (the other being Panera). At the same time, consumers are increasingly aware of food quality and wholesomeness. CMG is a pioneer in this area among restaurants and has created a significant competitive advantage with its all-natural supply chain.

How this call fits with out broader thinking: Stock picking in 2010 for restaurants is likely to be more idiosyncratic, with a bias toward growth (both domestic in the case of CMG or PFCB) and international (in the case of YUM). While early in the year we have a bias toward the casual diners as the consumer recovers, they think QSR will look attractive by midyear as we begin to lap the slowdown of last summer.

Morgan Stanley is raising their estimates on CMG for 4Q09 (to $0.89 from $0.84) and 2010 (to $4.45 from $4.00). Much of their increase is predicated on belief that the current run rate of restaurant margins will carry over into 2010 (24.7% now vs. MSCO's prior estimate of 23.8%), as well as their increased confidence in SSS growth (now +3% vs. prior +1.6% estimate).

CMG is the fastest grower in restaurants — with still industry leading returns. Entering this recession, there were no fewer than a dozen public restaurant chains that could claim the mantel of a growth stock, each with unit growth rates of 15%+ and EPS growth rates of 15%+. Exiting this recession, that list has been pared to just 3–4 companies that can maintain unit growth and EPS growth of mid teens and low 20% respectively, and only one, CMG, that has a market cap of more than $1 billion. CMG has not only the best rate of growth but also the best unit economics in the cohort. In firm's view, this scarcity of growth should be reflected in a premium valuation for those companies that have demonstrated growth. Currently, CMG shares do not reflect that growth scarcity premium that they think they ought to.

Raising their price target on CMG to $111, or 25x 2010e EPS. Firm notes they believe this multiple, below the historical average P/E of 32x since the 2006 IPO but still a premium to current valuation, is reasonable in light of expected 20–25% future EPS growth and best-in-class ROIC. Their target multiple represents a PEG ratio premium of 1.0–1.2x, a far lower PEG ratio than historical averages for best-in-class growers of 1.4x, but more appropriate in firm's view given the expected more muted consumer spending environment over the next few years. The 20-year average PEG ratio for growth restaurants is 1.0x, and they feel given CMG’s best in class returns currently that it warrants a 10–20% premium to that historical average.

Alternative valuation metrics also supportive. On an EBITDA basis, CMG shares trade at under ~9x 2010e EBITDA, a slight premium to peers especially in light of the fact that CMG has no funded debt. Similarly, on a FCF-yield basis, shares trade at ~4%, lower than peer average of ~10%, largely due to deploying cash into growth. Unlike many peers, CMG has not slowed growth through this recession (developer delays not included).

Notablecalls: Growth story, best in class operating margins & Morgan Stanley reversing their previous negative stance saying there could be 10% upside to current consensus EPS. All this coupled with a ~40% short interest.

The shorts lost an important ally.

This one should work. I'm guessing CMG can trade to $90 and $91.50 if the market plays ball & we get the stock moving.

Let's see how it works out.

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