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When short-seller David Einhorn announced a few weeks ago that Chipotle Mexican Grill was his new pick for a stock to fall, much of the attention was heaped on his assertion that the company's No. 1 problem was competition from Taco Bell.

Since then, Chipotle has done nothing to throw the call back in Mr. Einhorn's face; after an earnings miss and disappointing sales outlook last week, the shares have continued their sharp fall. After hitting an all-time high of $442 in mid-April, Chipotle stock set another 52-week low Monday of $237.50.

While it's tempting to congratulate Mr. Einhorn for another prescient call – he tagged the overhyped Green Mountain Coffee Roasters when few others were willing to do so – the idea that Taco Bell's new "Cantina Bell" menu poses a significant problem to Chipotle is laughable to anyone who has actually eaten at both restaurants.

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However – before you run out and buy Chipotle shares on the premise they've been knocked down by undue pessimism, realize that Chipotle's issues are broader and more nuanced than any purported challenge from Taco Bell. In short (so to speak), Chipotle's shares deserve their drubbing, but for reasons other than the one that grabbed all the headlines.

First, some history: Before I took over the Vox column, but while writing articles for Globe Investor, I suggested Chipotle's share price was "too spicy" and investors needed to wait for a better entry point. That was August, 2010, when shares were $150; anyone who took that advice missed a nearly 200 per cent gain in 20 months. It is one of my worst calls ever.

However, what I said at the time was this: "The hazard is whether any little disappointment will send momentum investors scurrying."

That's what's happening now, although the current news for Chipotle is more than a little disappointing. The problem isn't the third-quarter same-store sales growth of 4.8 per cent; it's the guidance for 2013, in which the company said it expects "flat to low-single-digit comparable restaurant sales" – sales in stores open at least one year. Analyst Andy Barish of Jefferies & Co. believes the first-quarter figure could actually be negative as Chipotle must compare with last year's mild winter.

The slowing of sales suggests margins may shrink in 2013. Commodity cost inflation has already hurt Chiptle, although cheap avocados for the chain's guacamole offset increases in other areas. Additionally, health-care costs for its employees are expected to rise.

To his credit, Mr. Einhorn mentioned several of these factors in making his case for shorting the stock, even before the earnings report came out. However, he cited Taco Bell's higher-priced "Cantina Bell" menu as Chipotle's primary problem, even urging attendees of the Value Investing Conference to try both chains to see the problem.

In the name of research, I have done so. Let me be clear: I am not a food snob. I have eaten at both, although I was taking a break from Taco Bell after a recent incident with refried beans. I ventured back in last week and had a Cantina Burrito, which was about half the cost of a Chipotle burrito with guacamole. I left Taco Bell hungry, and the spot price of natural gas declined that afternoon due to a sudden oversupply in my office. It's hard to see someone who eats regularly at Chipotle deciding that Taco Bell has produced a long-term substitute.

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That being said, however, there also seems to be an upper limit for Chipotle's growth. The company's leaders are natural-food evangelists who believe they are riding the wave of a revolution in the way we eat. I agree natural and organic foods are growing in popularity; I also think we're running out of people willing to pay the price premium they currently command.

Even with the sharp drop, however, the market seems not to agree, as Chipotle's shares are still priced for growth. Since analysts expect roughly $10 in earnings per share in the next four quarters, the forward price-to-earnings ratio remains around 24, an awfully large number for a company that just said it expects "flat" comparable sales.

There are a number of analysts who say the recent retreat is a good opportunity to get in on a company that still plans 160-plus new locations a year, and has produced amazing profits soon after opening its existing restaurants. However, the appropriately named Mr. Barish, who has an "underperform" rating and a price target of $215, notes that if Chipotle produces a below-expectation EPS of $9.34, combined with multiple compression to 18, shares could fall to $168.

I'll gladly keep paying up for Chipotle's burritos. It's the share price that gives me indigestion.

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About the Author
Business and investing reporter and columnist

A business journalist since 1994, David Milstead began writing for The Globe and Mail in 2009. During eight years at the Rocky Mountain News in Denver, Colo., he individually or jointly won nine national awards from SABEW, the Society of American Business Editors and Writers. He has also worked at the Wall Street Journal. More


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