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Chipotle Mexican Grill(CMG-N)

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Chipotle Stock: Buy the Dip?

Motley Fool - Fri Aug 11, 6:16AM CDT

Chipotle Mexican Grill(NYSE: CMG), the renowned fast-casual restaurant chain, has seen its stock take a hit since it released its second-quarter 2023 earnings late last month. The stock has pulled back nearly 12% since the report. Is this a buying opportunity, or should investors hope for an even better price before taking the plunge and buying shares of this enduring company?

Interestingly, the fast-casual burrito chain's second-quarter earnings actually surpassed analysts' consensus forecast for the quarter. So what is going on with the stock? Let's take a look at the earnings report and, more importantly, assess whether or not shares are a buy today now that the stock has come down meaningfully.

Two areas that spooked investors

Chipotle's adjusted earnings per share for Q2 impressively rose 36% year over year to $12.65. This beat analysts' average estimate for $12.31. This positive performance is attributed to various factors, including improved restaurant-level operating margin expansion, menu innovation, price increases, and good execution on the company's digital strategies.

Despite the company's positive business momentum, a few items in the report seemed to spook investors. Chipotle's second-quarter sales were slightly below estimates, and management's guidance for its third-quarter comparable restaurant sales growth rate missed expectations. Specifically, Chipotle's revenue rose 13.6% year over year to about $2.50 billion, missing analysts' forecast for $2.53 billion. Additionally, management said it expected its third-quarter comparable restaurant sales to increase at a rate in the "low to mid-single digit range," compared to analysts' estimate for growth of 5.9%.

Investors should note, however, that Chipotle was confident enough about its underlying business momentum that it left its outlook for full-year comparable restaurant sales the same. For the full year of 2023, management expects comparable restaurant sales to increase at a rate in the mid- to high single-digit range.

Altogether, Chipotle didn't give investors a good reason to be disappointed. After all, the company's bottom line is trending ahead of expectations and management still expects full-year comparable restaurant sales to grow rapidly. So even though the market may have been spooked, business momentum is undeniably strong.

What about valuation?

The issue with Chipotle stock boils down to valuation. Indeed, perhaps the growth stock's recent decline had more to do with shares taking a breather, with the earnings report serving as the catalyst. After all, shares are still up 33% year to date.

On the surface, Chipotle stock might seem grossly overvalued. Shares trade at about 50 times earnings. But investors expect a combination of sustained levels of robust revenue growth rates and substantial operating margin expansion over the next five years to drive huge earnings growth. The consensus analyst forecast currently calls for Chipotle's adjusted earnings per share to grow at a compound annual growth rate of about 25% over this period. If this occurs, Chipotle could live up to its valuation.

Still, investors may want to bake in a material margin of safety before they buy the stock. After all, there's always the possibility that Chipotle's growth over the next five years will come in slower than expected. There's no reason to rush in to buy shares at nearly 50 times earnings. Instead, waiting to see if the stock's recent slide worsens may make sense. Shares would start to look compelling at around 42 to 44 times earnings.

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Daniel Sparks has no position in any of the stocks mentioned. His clients may own shares of the companies mentioned. The Motley Fool has positions in and recommends Chipotle Mexican Grill. The Motley Fool has a disclosure policy.

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