Key Points
People have become cautious about spending.
Sales growth should pick up when conditions improve.
Chipotle's shares trade at a better valuation now.
Sometimes, the stock market overreacts to short-term news and events. When this happens, it's up to astute investors to quickly seize upon the opportunity. After all, the market adapts pretty quickly, and high-quality companies don't trade at an attractive valuation forever. You'll need to have patience, however.
Chipotle Mexican Grill (NYSE: CMG) falls into this category. The stock deserves serious consideration, despite reporting disappointing sales. Here's why results, and in turn, the share price, should see a sharp recovery.
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Cyclical factors are hurting sales
It's undeniable that Chipotle's sales have been sluggish for some time. First-quarter same-store sales (comps) increased a tepid 0.5%, and management expects flat comps for the year. But the overall fast-casual restaurant sector has seen a sales slowdown, indicating cyclical factors at work, rather than secular issues.
However, there was some positive news that investors should watch to see if it continues. Increased visits contributed 0.6 percentage points, indicating people still like going to the fast-casual restaurant chain. They've just been wary about discretionary spending due to bigger economic factors like higher gas prices. Spending subtracted 0.1 percentage points from comps as customers ordered lower-priced menu items.
Unfortunately, Chipotle's costs have been rising faster than sales, squeezing profitability. Its first-quarter operating income dropped 17.1% year over year to $397.1 million.
Nonetheless, management clearly has confidence in the company's long-term future. It continues to open new restaurants, including 48 (net of one closure) in Q1, bringing the total to 4,090. The company expects to open 350 to 370 locations this year.
Cheap valuation
Investors certainly haven't been pleased with the results. Over the past year, through July 16, the share price lost nearly 36%. That badly trailed the S&P 500 index's 20.3% gain.
However, that's also created a much better stock valuation. Over the past year, the shares' price-to-earnings (P/E) ratio has gone from 45 to 31. Chipotle's stock has a five-year median P/E ratio of 52. The current valuation is roughly in line with the S&P 500 consumer discretionary sector's P/E multiple of 30.
If people were specifically avoiding Chipotle for company-specific reasons, I'd find that concerning. But that doesn't appear to be the case. At some point, economic pressures will ease, and people will go back to eating at Chipotle, where they can find reasonably priced, high-quality food.
When that happens, sales growth will accelerate, and earnings will rebound. Investors who purchased Chipotle's shares at this less expensive valuation will undoubtedly look back fondly.
Lawrence Rothman, CFA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chipotle Mexican Grill. The Motley Fool recommends the following options: short September 2026 $35 calls on Chipotle Mexican Grill. The Motley Fool has a disclosure policy.