Harvard vs. Einhorn: Chipotle Mexican Grill (CMG)

On September 24th-25th, I traveled to Ithaca, New York with two Harvard classmates, Linxi Wu and Jared Sleeper, to compete in the Cornell Undergraduate Stock Competition.

The Rules: There were six teams total, each comprised of three members. Teams from Harvard (us), Wharton, Cornell, MIT, Columbia, and Dartmouth were represented.

One week before the competition, we were given the stocks to analyze. For the first round, everyone had to analyze Chipotle (CMG). You could recommend a buy, hold, or short. Presentation time was 10 minutes with 5 minutes of Q&A from the judges from Fidelity and Putnam Investments. Three of the six teams would be selected to compete in the final round where each team was given a choice among four education stocks: DV, COCO, APOL, and BPI.

Our CMG pitch earned us a spot in the final round along with the teams from Wharton and Cornell. Our pitch on DV earned us first place overall in the competition with Wharton in 2nd and Cornell in 3rd.

I went in thinking we would probably go short CMG. After all, it’s a restaurant stock at 20X EBITDA and 40X earnings.. cmon right?! The inner value investor in me cringed at that type of valuation. However, as we really dug in every night and tried to understand the business and build out our valuation model, I really came away much more bullish on CMG with a price target of $406.50 (~45% undervalued).

Recently (and after our pitch), David Einhorn came out recommending a short of Chipotle based primarily on increasing competition from Taco Bell combined with its high valuation. Einhorn is one of my favorite investors (if not my favorite), but I was very surprised by his pitch. It honestly seemed so much less sophisticated than his excellent short call on Green Mountain Coffee (GMCR).

The GMCR short pitch was a 100+ page PowerPoint presentation focused on accounting issues that other investors were not properly accounting for. The CMG pitch is just: high valuation + increased competition from Taco Bell? Really?

High Valuation: I also thought 20X EBITDA was way too expensive… until I really dug into the numbers. CMG is less than halfway to reaching U.S. market saturation and I think they are likely to grow into their valuation over time. As you can see in the presentation and the model assumptions, 20X EBITDA is not always expensive. As we point out in our presentation, CMG was trading at an even higher P/E ration in 2006 (44.5X) and has returned 37.6% annually, crushing the market. Just looking at a single metric just doesn’t cut it for such a high growth company.

Taco Bell and their new Cantina Menu: Taco Bell has been around for decades and they are just now putting their emphasis on the Cantina Menu. Why? Because it’s not that great of an idea! If it was such an easy sell and market opportunity for them, this would have come out years ago. While it may have some success, I don’t think anyone is going to start confusing Taco Bell for Chipotle. When we analyzed this issue, we likened this to McDonald’s rolling out their McCafe coffee. Sure some people buy their coffee now from McDonald’s, but this has not cannibalized SBUX or their long-term prospects.

Here is the PowerPoint presentation for CMG:

I am a special situations oriented value investor, so high growth stocks like Chipotle normally don’t find a place in my portfolio. That being said, if I had to go long or short, I’d go long from these levels and I think going short is way too risky. Shorting a strong business is a loser’s game in my opinion. Even if you are right (which I don’t think Einhorn is here), momentum can kill you. Should be interesting to see how this plays out.

Here is the PowerPoint presentation for DV (there will be a separate post later).

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Disclaimer: The content contained in this blog represents only the opinions of its author(s). I may hold long or short positions in securities mentioned in the blog. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. This blog is not a solicitation of business– the content herein is intended solely for the entertainment of the reader and the author.